Question

The estimated purchase price for the equipment required to move the operation in-house would be $750,000. 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 $35,000 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 $1,200,000. The estimated cash flow savings of bringing the process in-house is 20% or annual savings of $240,000. 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 $50,000. (i.e. the terminal value).

Shawn 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. Stanley feels that the stated terminal value is reasonable and used it in his calculations.

Answer 1

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