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The new equipment would allow your company to manufacture a critical component in-house instead of buying it from a supplier. This capability would help you

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The new equipment would allow your company to manufacture a critical component in-house instead of buying it from a supplier. This capability would help you stabilize your supply chain (which has suffered from some irregularities and quality issues in the past). It could also have a positive impact on profitability through the absorption of fixed costs since this new machine will have plenty of excess capacity. There may even be a possibility that the company could leverage this capability to create a new external revenue stream by providing services to other companies. The company has been growing steadily over the past 5 years, and the financials and future prospects look good. Your CEO has asked you to run the numbers. After doing some digging into the business, you have gathered information on the following: - The estimated purchase price for the equipment required to move the operation in-house would be $700,000. 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 $30,000 per year starting in year 0 and through all years of the project to support production as raw materials will be required in year o and all years to run the new equipment and produce components to replace those purchased from the vendor. - The current spending on this component (i.e., annual spend pool) is $1,500,000. The estimated cash flow savings of bringing the process in-house is 16.67% or annual savings of $250,000. This includes the additional labor and overhead costs required. - 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 the end of the project (the last year of generated cash flow) for $30,000. (i.e. the terminal value). 1. Angela, your colleague from Accounting, recommends using the base assumptions above: 5-year project life, flat annual savings, and 10% discount rate. Angela does not feel the equipment will have any terminal value due to advancements in technology. 2. Bob from Sales is convinced that this capability would create a new revenue stream that could significantly offset operating expenses. He recommends savings that grow each year: 5 -year project life, 10% discount rate, and a 10% annual savings growth in years 2 through 5 . In other words, instead of assuming savings stay flat, assume that they will grow by 10%% in year 2 , and then grow another 10% over year 2 in year 3 , and so on. Bob feels that the stated terminal value of $30,000 is reasonable and used it in his calculations. 3. Carl 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. Carl 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. He argues that, while it is difficult to quantify the potential negative impacts, to account for the risk, a 15% discount rate should be used. Being an engineer, Carl feels that the stated terminal value is low based on his experience and is recommending a $55,000 terminal value. The new equipment would allow your company to manufacture a critical component in-house instead of buying it from a supplier. This capability would help you stabilize your supply chain (which has suffered from some irregularities and quality issues in the past). It could also have a positive impact on profitability through the absorption of fixed costs since this new machine will have plenty of excess capacity. There may even be a possibility that the company could leverage this capability to create a new external revenue stream by providing services to other companies. The company has been growing steadily over the past 5 years, and the financials and future prospects look good. Your CEO has asked you to run the numbers. After doing some digging into the business, you have gathered information on the following: - The estimated purchase price for the equipment required to move the operation in-house would be $700,000. 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 $30,000 per year starting in year 0 and through all years of the project to support production as raw materials will be required in year o and all years to run the new equipment and produce components to replace those purchased from the vendor. - The current spending on this component (i.e., annual spend pool) is $1,500,000. The estimated cash flow savings of bringing the process in-house is 16.67% or annual savings of $250,000. This includes the additional labor and overhead costs required. - 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 the end of the project (the last year of generated cash flow) for $30,000. (i.e. the terminal value). 1. Angela, your colleague from Accounting, recommends using the base assumptions above: 5-year project life, flat annual savings, and 10% discount rate. Angela does not feel the equipment will have any terminal value due to advancements in technology. 2. Bob from Sales is convinced that this capability would create a new revenue stream that could significantly offset operating expenses. He recommends savings that grow each year: 5 -year project life, 10% discount rate, and a 10% annual savings growth in years 2 through 5 . In other words, instead of assuming savings stay flat, assume that they will grow by 10%% in year 2 , and then grow another 10% over year 2 in year 3 , and so on. Bob feels that the stated terminal value of $30,000 is reasonable and used it in his calculations. 3. Carl 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. Carl 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. He argues that, while it is difficult to quantify the potential negative impacts, to account for the risk, a 15% discount rate should be used. Being an engineer, Carl feels that the stated terminal value is low based on his experience and is recommending a $55,000 terminal value

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