CASE #3: Paccar's Buy or Build Decision - Applying Risk Assessment Tools

As you already know, Paccar is considering either purchasing (buy) or developing in-house (build) new technology for their two major lines of trucks.Based on your initial quantitative analysis, the build option is expected to have a higher NPV, IRR, MIRR and a lower payback period and, therefore, it appears to be the better alternative.Your initial analysis was completed using an estimate of Paccar's WACC as the required return (discount rate) and point estimates for each of the various inputs.Mr. Harquest would like you to revisit the analysis focusing on the consequences associated with the greater risk exposure associated with developing (building) the new technology.

To assess the additional risk associated with developing the new technology, Mr. Harquest would like you to apply several risk assessment tools using Paccar's WACC (5.5%) as the required return.More specifically, he wants you to apply the following risk assessment tasks. First, Mr. Harquest would like you to determine the level of development costs that would make Paccar indifferent between buying and developing the new technology.Similarly, he wants to know what is the level of increased revenue in year one if we develop the technology that would make Paccar indifferent between buying and developing the new technologyAdditionally, he would also like you apply two-way sensitivity analysis to the NPV of developing the new technology based on the expected increase in year 1 revenue and growth in increased revenue in years 2 and 3.Furthermore, Mr. Harquest would also like you to apply scenario analysis by estimating all four performance measures for the develop alternative assuming it takes 21 months to develop the technology, the cost of developing the new technology will be 60% greater than originally expected, and the increase in revenue in year 1 is 30% lower than originally expected (keep the growth rate the same)[1].He suggests that it is reasonable to assume that the probability of this scenario occurring is 20% while the probability of our original expectations occurring is 80%.Finally, Mr. Harquest would like you apply Monte Carlo Simulation Analysis (focusing only on our key performance measure: NPV) separately for both alternatives (buy and develop) given the expected distribution of the inputs provided in exhibit 1.

Mr. Harquest is expecting a well written two to three page (double spaced, font size of 12 with reasonable margins) summary of your analysis.The introductory paragraph should let the reader know what is going to be analyzed and why and mentions the tools to be applied. The body of this summary should contain a separate paragraph for each risk assessment task that describes the procedure, the results, and the implication of the results for our decision to buy or develop the new technology.The concluding paragraph should summarize your key results and provide a recommendation based on the entirety of your analysis and any remaining non-quantifiable factors.Feel free to attach as many self explanatory exhibits as necessary.Mr. Harquest is expecting your report late in the afternoon on Tuesday, May 1^st.