Question
Based on the following: The estimated purchase price for the equipment required to move the operation in-house would be $500,000. Additional net working capital to
Based on the following:
- The estimated purchase price for the equipment required to move the operation in-house would be $500,000. Additional net working capital to support production (in the form of cash used in Inventory, AR net of AP) would be needed in the amount of $25,000 per year starting in year 0 and through all 5 years of the project to support production.
- The current spending on this component (i.e. annual spend pool) is $875,000. The estimated cash flow savings of bringing the process in-house is 20% or annual savings of $175,000. This includes the additional labor and overhead costs required.
- Your company has access to a credit line and could borrow the funds at a rate of 6%.
- Finally, the equipment required is anticipated to have a somewhat short useful life, as a new wave of technology is on the horizon. Therefore, it is anticipated that the equipment will be sold after five years for $25,000. (i.e. the terminal value).
Your colleague from Engineering believes we use a higher Discount Rate because of the risk of this type of project. As such, she is recommending a 5-year project life and flat annual savings. She suggests that even though the equipment is brand new, the updated production process could have a negative impact on other parts of the overall manufacturing costs. She argues that, while it is difficult to quantify the potential negative impacts, to account for the risk, a 14% discount rate should be used.
Using the data presented above (and ignoring the extraneous information), for this profit and supply chain improvement project, calculate each of the following (where applicable): Show Calculations
o Nominal Payback
o Discounted Payback
o Net Present Value
o Internal Rate of Return
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