United Technologies Corporation 1 United Technologies Corporation (UTC) is a provider of high technology products and services to the building systems and aerospace industries: The Company History In 1974, Harry Gray left Litton Industries to become the CEO of United Aircraft. [7] He pursued a strategy of growth and diversification, changing the parent corporation's name to United Technologies Corporation (UTC) in 1975 to reflect the intent to diversify into numerous high tech fields beyond acrospace. [81 (The change became official on May 1, 1975.) The diversification was partially to balance civilian business against any overreliance on military business. [1] UTC became a mergers and acquisitions (M\&A)-focused organization, with various acquired Otis Elevator. 191 In 1979, Carrier Refrigeration and Mostek were acquired; 100 the Carrier deal was forcible, while the Mostek deal was a white knight move against hostile takeover designs by Gould. At one point, the military portion of UTC's business, whose sensitivity to "excess profits" and boom/bust demand "drove UTC to diversify away from it, actually carried the weight of losses incurred by the commercial M\&A side of the business. 173 Although M\&A activity was not new to United Aircraft, the M\&A activity of the 1970 s and 1980 s was higher-stakes and arguably unfocused. Rather than aviation being the central theme of UTC businesses, high tech (of any type) was the new theme. Some Wall Street watchers questioned the true value of M\&A at. almost any price, seemingly for its own sake. [I] Mostek was sold in 1985 to the French electronics company Thomson In 2007, UTC opened the Hawk Works, a Rapid Prototyping and Military Derivatives Completion Center (RPMDCC) located west of the Elmira-Corning Regional Airport in Big Flats, New York, [11] In March 2008, UTC made a \$2.63 billion bid to acquire Diebold, a Canton, Ohio based manufacturer of banking and voting machines. Diebold rejected the buyout bid as inadequate. [13 In April 2010, UTC announced that it was investing 15 million ( $20 million) to set up the United Technologies Research Centre Ireland at University College Cork's Tyndall National Institute which will carry out research on energy and security systems. [13] In June 2012, it was discovered that UTC sold military technology to the Chinese, 110 F For pleading guilty to violating the Arms Export Control Act and making false statements, United Technologies and its subsidiaries were fined $75 million. In February 2013, UTC Power was sold to ClearEdge Power, uel In October 2014, Ioshiba and United Technologies made a deal to expand their joint venture outside Japan. [12] In February 2016, UTC subsidiary Carrier Air Conditioner announced to employees at its Indianapolis and Huntington plants, that Carrier is moving manufacturing to Mexico: "The best way to stay competitive and protect the business for long-term is to move production from our facility in Indianapolis to Monterrey, Mexico. "1181 In December, Carrier agreed to keep the Indianapolis plant open, keeping 700 jobs in Indianapolis. 119 The plant in Huntington, Indiana would still close their doors, leaving 700 employees jobless. 200] The Company operates through four segments: The Collins's Aerospace Systems segment provides electric power generation, power management, and distribution systems; air data and aircraft sensing systems; engine control, intelligence, surveillance, and reconnaissance systems; engine components; environmental control systems; fire and ice detection, and protection systems; propeller systems; engine nacelle systems; aircraft lighting and seating, and cargo systems; actuation and landing systems; space products and subsystems; and aftermarket services. This segment also offers electronic security products, including intruder alarms, access control systems, and video surveillance systems; fire safety products; and design, installation, system integration, repair, maintenance, monitoring, and inspection services. Its Otis segment designs, manufactures, sells, and installs passenge. and freight elevators, escalators, and moving, walkways; and offers modernization products to upgrade elevators and escalators, as well as maintenance and repair services. Its Climate Controls \& Security segment provides heating, ventilating, air conditioning, and refrigeration solutions, such as controls for residential, commercial, industrial, and transportation applications. Its Pratt \& Whitney segment supplies aircraft engines for commercial, military, business iet, and general aviation markets; and provides aftermarket maintenance, repair, and overhaul, as well as fleet management services. For the fiscal year 2017, United Technologies reported sales of $57,244,000 and net income of $3,402,600, an increase of 9% over the previous fiscal year. Capital Expenditures On January 2, 2018, Frederic Michael, CFO and Treasure, prepared the details of six projects that the company was considering for her meeting with the Capital Budget Committee (CBC). Table1 shows the cash flows and cost of each project. The total cost of these projects is $1,675,000. The Company has imposed a spending limit on the total investment and have mandated to not exceed the firm's internal funds. With the new fiscal year, there is a need to determine which projects best fits the Company's future growth value enhancement. Thus, the challenge for the Committee is to allocate the funds among competing projects efficiently to increase the Company's value. The proposed projects presently under consideration will enable us efficiently to expand our productivity to meet ever-increasing customers demand with high quality engineered products and systems for all four segments. CAPITAL BUDGETING PROCESS The capital budgeting process at UTC Company is centralized and each segment is responsible for its own project development with the final approval of capital expenditures by the Capital Budget Committee (CBC) of the company. The Capital Budget Committee that consisted of Robert Harris Chairman, President and Chief Executive Officer, Jon Jeffery Vice President, and Frank Koller Executive Vice President and Frederic Michael Vice President-Finance, CFO and Treasurer with his two assistants, Kim Johnson, Controller and Patricia Hopkins, CFA Director -Investor Relations was considering all proposed capital outlays from the three segments (Table-1). During the meeting, debate was centered on the most appropriate capital budgeting criteria for evaluating all the projects. The committee was concemed that all the projects to be considered were independent, and perhaps the usual capital budgeting criteria of NPV was appropriate. In response to the committee, Frederic Michael suggested that, perhaps they should use relative profitability or some measure of expected rate of return criteria because the Company did not have enough capital for all the projects. Kim Johnson agreed with Frederic Michael and recommended the profitability index (PI). She argued that the profitability index would provide a benefit-cost ratio which would take relative size of cach investment outlay into consideration. Patricia Hopkins, a recent graduate, and CFA, agreed with both, however, she argued that the use of internal rate of retum would also provide a measure of relative profitability and would also take into consideration the relative size of each capital outlay. Robert Harris stated that as you know, for the last three years we have paid 60 percent of the net income in dividends, and it is expected to grow at a constant rate of 5 percent in the future. He continued that a 12 percent cost of capital for funds generated internally has been used in the past, and he sees no reason to depart from this figure. To resolve the issue, Harris suggested that the projects should be analyzed by all three measures, as they would undoubtedly result in the same ranking. \begin{tabular}{|l|r|r|r|} \hline Other Liabilities & $14,858,000 & $14,794,400 & $15,614,200 \\ \hline Minority Interest & $1,590,000 & $1,486,000 & $1,351,000 \\ \hline Total Liabilities & $60,051,000 & $56,919,400 & $588,224,200 \\ \hline Stockholders' Equity & & & \\ Misc. Stocks Options Warrants & $296,000 & $122,000 & $140,000 \\ Common Stock (450,000 shares) & $18,901,000 & $16,033,000 & $15,300,000 \\ Retained Earnings & $41,257,000 & $39,895,960 & $38,611,000 \\ Treasury Stock & $26,022,000 & $23,781,000 & $21,922,000 \\ Other Stockholder Equity & $8,429,000 & $7,724,000 & $6,776,000 \\ Total Stockholder Equity & $26,003,000 & $24,545,960 & $25,353,000 \\ \hline Total Lib. and Equity & $86,054,000 & $81,465,360 & $83,577,200 \\ \hline \end{tabular} Table-4 Statement of Cash Flows Suggested Questions Part 1 a. What is the total investment and how much funds are available for investment? b. Calculate the NPV of each project and indicate the total investments which would meet the available funds. c. Calculate the internal rate of retum (IRR) of each project and compare them against the book value and market value weighted average cost of capital. d. Select the best investment based on their IRR and indicate the total cost and benefits, e. Calculate the PI of each project and indicate the total investments which would meet the available funds? f. Compare your the results in part d,f, and g. Are they resulted in the same investment and total costs? Explain. g. Based on your answers in part d,f, and g what would you recommend to the CBC? Part II Although the risk of each segment is different, the Committee used the company's historical cost of capital to evaluate the cost and benefit of each project. However, Smith was worried that the historical cost of capital might not reflect the risk of the projects nor the overall risk of the company. This lack of risk consideration was more evident when the company's beta was below one and especially most of its competitors have almost have the same beta as his company. Janet Johnson and Patricia Hopkins suggested that the risk characteristic of cach project could be considered if the segment risk-adjusted discount rate was used. Bassett argued that it would be difficult to develop risk-adjusted hurdle rates for each segment. Estimation of the risk-adjusted rate for each project would involve collection of the enormous data and then analysis of the information against other projects. Both Johnson and Otis agreed with Bassett, and they felt that segment risk could be considered, if different rates were used for different segments. They indicated that one way of estimating segmental rate was to calculate the risk-adjusted discount rate for each segment by using capital asset pricing model (CAPM). When they were asked about the CAPM, they replied: The process of CAPM involves a conceptual framework for estimating the systematic risk and hence the risk-adjusted discount rate of each segment based on its beta coefficient which is a measure of the sensitivity of segment's return to market fluctuations. However, Jon Anderson Vice President, and Fran Otto Executive Vice President were not impressed by the concept of the segmental cost of capital. Specifically, they questioned, how the segmental cost of equity could be calculated when there was no separate financial information for cach segment. They argued that the capital asset pricing model builds on the risk-premium approach, which considers the volatility of the stock in question. It uses the stock's beta (the covariance of the stock's rate of return with average rate of retum of a market index) as a measure of risk which might not be representative of the segment risk. One way to estimate the risk-adjusted cost of equity is to use the information of the comparable companies. They continued that it is possible to calculate the weighted average cost of capital based on risk-adjusted cost of equity and debt. Below is the financial information of comparable companies. The 30-year long-term debt with a par value of $1,000 was issued 10 years ago with a coupon rate of 8%, however, it could be relinanced at the market interest rate of 10 percent today and tax rate in 2017 was 25%. The Company has a beta of 0.72. The risk-free rate is 5% and rate of the market risk premium 6.0%. h. Determine the market value of the capital structure. i. Determine the weighted average cost of capital (WACC). j. Compare the required rate of return with expected rate of return, which project is appropriate to take? k. Compare the results of Part I and Part II and explain your finding. 1. In April 2020 UTC merged with the Raytheon Company to form Raytheon Technologies, = 2. Wikipedia. 3. UTC was a public company when the case was written. United Technologies Corporation 1 United Technologies Corporation (UTC) is a provider of high technology products and services to the building systems and aerospace industries: The Company History In 1974, Harry Gray left Litton Industries to become the CEO of United Aircraft. [7] He pursued a strategy of growth and diversification, changing the parent corporation's name to United Technologies Corporation (UTC) in 1975 to reflect the intent to diversify into numerous high tech fields beyond acrospace. [81 (The change became official on May 1, 1975.) The diversification was partially to balance civilian business against any overreliance on military business. [1] UTC became a mergers and acquisitions (M\&A)-focused organization, with various acquired Otis Elevator. 191 In 1979, Carrier Refrigeration and Mostek were acquired; 100 the Carrier deal was forcible, while the Mostek deal was a white knight move against hostile takeover designs by Gould. At one point, the military portion of UTC's business, whose sensitivity to "excess profits" and boom/bust demand "drove UTC to diversify away from it, actually carried the weight of losses incurred by the commercial M\&A side of the business. 173 Although M\&A activity was not new to United Aircraft, the M\&A activity of the 1970 s and 1980 s was higher-stakes and arguably unfocused. Rather than aviation being the central theme of UTC businesses, high tech (of any type) was the new theme. Some Wall Street watchers questioned the true value of M\&A at. almost any price, seemingly for its own sake. [I] Mostek was sold in 1985 to the French electronics company Thomson In 2007, UTC opened the Hawk Works, a Rapid Prototyping and Military Derivatives Completion Center (RPMDCC) located west of the Elmira-Corning Regional Airport in Big Flats, New York, [11] In March 2008, UTC made a \$2.63 billion bid to acquire Diebold, a Canton, Ohio based manufacturer of banking and voting machines. Diebold rejected the buyout bid as inadequate. [13 In April 2010, UTC announced that it was investing 15 million ( $20 million) to set up the United Technologies Research Centre Ireland at University College Cork's Tyndall National Institute which will carry out research on energy and security systems. [13] In June 2012, it was discovered that UTC sold military technology to the Chinese, 110 F For pleading guilty to violating the Arms Export Control Act and making false statements, United Technologies and its subsidiaries were fined $75 million. In February 2013, UTC Power was sold to ClearEdge Power, uel In October 2014, Ioshiba and United Technologies made a deal to expand their joint venture outside Japan. [12] In February 2016, UTC subsidiary Carrier Air Conditioner announced to employees at its Indianapolis and Huntington plants, that Carrier is moving manufacturing to Mexico: "The best way to stay competitive and protect the business for long-term is to move production from our facility in Indianapolis to Monterrey, Mexico. "1181 In December, Carrier agreed to keep the Indianapolis plant open, keeping 700 jobs in Indianapolis. 119 The plant in Huntington, Indiana would still close their doors, leaving 700 employees jobless. 200] The Company operates through four segments: The Collins's Aerospace Systems segment provides electric power generation, power management, and distribution systems; air data and aircraft sensing systems; engine control, intelligence, surveillance, and reconnaissance systems; engine components; environmental control systems; fire and ice detection, and protection systems; propeller systems; engine nacelle systems; aircraft lighting and seating, and cargo systems; actuation and landing systems; space products and subsystems; and aftermarket services. This segment also offers electronic security products, including intruder alarms, access control systems, and video surveillance systems; fire safety products; and design, installation, system integration, repair, maintenance, monitoring, and inspection services. Its Otis segment designs, manufactures, sells, and installs passenge. and freight elevators, escalators, and moving, walkways; and offers modernization products to upgrade elevators and escalators, as well as maintenance and repair services. Its Climate Controls \& Security segment provides heating, ventilating, air conditioning, and refrigeration solutions, such as controls for residential, commercial, industrial, and transportation applications. Its Pratt \& Whitney segment supplies aircraft engines for commercial, military, business iet, and general aviation markets; and provides aftermarket maintenance, repair, and overhaul, as well as fleet management services. For the fiscal year 2017, United Technologies reported sales of $57,244,000 and net income of $3,402,600, an increase of 9% over the previous fiscal year. Capital Expenditures On January 2, 2018, Frederic Michael, CFO and Treasure, prepared the details of six projects that the company was considering for her meeting with the Capital Budget Committee (CBC). Table1 shows the cash flows and cost of each project. The total cost of these projects is $1,675,000. The Company has imposed a spending limit on the total investment and have mandated to not exceed the firm's internal funds. With the new fiscal year, there is a need to determine which projects best fits the Company's future growth value enhancement. Thus, the challenge for the Committee is to allocate the funds among competing projects efficiently to increase the Company's value. The proposed projects presently under consideration will enable us efficiently to expand our productivity to meet ever-increasing customers demand with high quality engineered products and systems for all four segments. CAPITAL BUDGETING PROCESS The capital budgeting process at UTC Company is centralized and each segment is responsible for its own project development with the final approval of capital expenditures by the Capital Budget Committee (CBC) of the company. The Capital Budget Committee that consisted of Robert Harris Chairman, President and Chief Executive Officer, Jon Jeffery Vice President, and Frank Koller Executive Vice President and Frederic Michael Vice President-Finance, CFO and Treasurer with his two assistants, Kim Johnson, Controller and Patricia Hopkins, CFA Director -Investor Relations was considering all proposed capital outlays from the three segments (Table-1). During the meeting, debate was centered on the most appropriate capital budgeting criteria for evaluating all the projects. The committee was concemed that all the projects to be considered were independent, and perhaps the usual capital budgeting criteria of NPV was appropriate. In response to the committee, Frederic Michael suggested that, perhaps they should use relative profitability or some measure of expected rate of return criteria because the Company did not have enough capital for all the projects. Kim Johnson agreed with Frederic Michael and recommended the profitability index (PI). She argued that the profitability index would provide a benefit-cost ratio which would take relative size of cach investment outlay into consideration. Patricia Hopkins, a recent graduate, and CFA, agreed with both, however, she argued that the use of internal rate of retum would also provide a measure of relative profitability and would also take into consideration the relative size of each capital outlay. Robert Harris stated that as you know, for the last three years we have paid 60 percent of the net income in dividends, and it is expected to grow at a constant rate of 5 percent in the future. He continued that a 12 percent cost of capital for funds generated internally has been used in the past, and he sees no reason to depart from this figure. To resolve the issue, Harris suggested that the projects should be analyzed by all three measures, as they would undoubtedly result in the same ranking. \begin{tabular}{|l|r|r|r|} \hline Other Liabilities & $14,858,000 & $14,794,400 & $15,614,200 \\ \hline Minority Interest & $1,590,000 & $1,486,000 & $1,351,000 \\ \hline Total Liabilities & $60,051,000 & $56,919,400 & $588,224,200 \\ \hline Stockholders' Equity & & & \\ Misc. Stocks Options Warrants & $296,000 & $122,000 & $140,000 \\ Common Stock (450,000 shares) & $18,901,000 & $16,033,000 & $15,300,000 \\ Retained Earnings & $41,257,000 & $39,895,960 & $38,611,000 \\ Treasury Stock & $26,022,000 & $23,781,000 & $21,922,000 \\ Other Stockholder Equity & $8,429,000 & $7,724,000 & $6,776,000 \\ Total Stockholder Equity & $26,003,000 & $24,545,960 & $25,353,000 \\ \hline Total Lib. and Equity & $86,054,000 & $81,465,360 & $83,577,200 \\ \hline \end{tabular} Table-4 Statement of Cash Flows Suggested Questions Part 1 a. What is the total investment and how much funds are available for investment? b. Calculate the NPV of each project and indicate the total investments which would meet the available funds. c. Calculate the internal rate of retum (IRR) of each project and compare them against the book value and market value weighted average cost of capital. d. Select the best investment based on their IRR and indicate the total cost and benefits, e. Calculate the PI of each project and indicate the total investments which would meet the available funds? f. Compare your the results in part d,f, and g. Are they resulted in the same investment and total costs? Explain. g. Based on your answers in part d,f, and g what would you recommend to the CBC? Part II Although the risk of each segment is different, the Committee used the company's historical cost of capital to evaluate the cost and benefit of each project. However, Smith was worried that the historical cost of capital might not reflect the risk of the projects nor the overall risk of the company. This lack of risk consideration was more evident when the company's beta was below one and especially most of its competitors have almost have the same beta as his company. Janet Johnson and Patricia Hopkins suggested that the risk characteristic of cach project could be considered if the segment risk-adjusted discount rate was used. Bassett argued that it would be difficult to develop risk-adjusted hurdle rates for each segment. Estimation of the risk-adjusted rate for each project would involve collection of the enormous data and then analysis of the information against other projects. Both Johnson and Otis agreed with Bassett, and they felt that segment risk could be considered, if different rates were used for different segments. They indicated that one way of estimating segmental rate was to calculate the risk-adjusted discount rate for each segment by using capital asset pricing model (CAPM). When they were asked about the CAPM, they replied: The process of CAPM involves a conceptual framework for estimating the systematic risk and hence the risk-adjusted discount rate of each segment based on its beta coefficient which is a measure of the sensitivity of segment's return to market fluctuations. However, Jon Anderson Vice President, and Fran Otto Executive Vice President were not impressed by the concept of the segmental cost of capital. Specifically, they questioned, how the segmental cost of equity could be calculated when there was no separate financial information for cach segment. They argued that the capital asset pricing model builds on the risk-premium approach, which considers the volatility of the stock in question. It uses the stock's beta (the covariance of the stock's rate of return with average rate of retum of a market index) as a measure of risk which might not be representative of the segment risk. One way to estimate the risk-adjusted cost of equity is to use the information of the comparable companies. They continued that it is possible to calculate the weighted average cost of capital based on risk-adjusted cost of equity and debt. Below is the financial information of comparable companies. The 30-year long-term debt with a par value of $1,000 was issued 10 years ago with a coupon rate of 8%, however, it could be relinanced at the market interest rate of 10 percent today and tax rate in 2017 was 25%. The Company has a beta of 0.72. The risk-free rate is 5% and rate of the market risk premium 6.0%. h. Determine the market value of the capital structure. i. Determine the weighted average cost of capital (WACC). j. Compare the required rate of return with expected rate of return, which project is appropriate to take? k. Compare the results of Part I and Part II and explain your finding. 1. In April 2020 UTC merged with the Raytheon Company to form Raytheon Technologies, = 2. Wikipedia. 3. UTC was a public company when the case was written