Assignment
In this assignment, you will demonstrate your understanding of capital investment techniques by evaluating the following three case studies.
In addition to your calculations for each scenario, you should submit a Word document in which you respond to the questions in each scenario.
Case Analysis 1
You work for a small, local telecommunications company. In five years, the company plans to undertake a major upgrade to its servers and other IT infrastructure.
Management estimates that it will need up to $450,000 to cover all related costs; however, as a fairly young company, the goal is to pay for the upgrade with cash and not to take out loans. Right now, you have $300,000 in a bank account established for Capital Investments.
This account pays 4% interest, compounded annually. A member of the finance department has approached you with an investment opportunity for the $300,000 that covers a five-year period and has the following projected after-tax cash flows:
|
Year
|
Projected Cash Flow
|
|
1
|
$90,000
|
|
2
|
$115,000
|
|
3
|
$135,000
|
|
4
|
$110,000
|
|
5
|
$90,000
|
Based on this information, in an MS Word document, answer the following questions:
1) How much money will be in the bank account if you leave the $300,000 alone (earning 4% compounded interest) until you need it in five years?
2) If you undertake the investment opportunity, what is the Nominal Payback Period?
3) Using the Present Value factors for 7% (which can be found on any PV Factor table), what is the discounted Payback Period of the investment opportunity?
4) What is the Net Present Value at 7% of the investment opportunity?
5) Which option (make the investment or leave the money in a savings account) would you recommend to your CEO? Why? What additional factors/information might make you change your point of view?
Case Analysis 2
The CEO of Dynamic Manufacturing was at a conference and talked to a supplier about a new piece of equipment for its production process that she believes will produce ongoing cost savings. As the Operations Manager, your CEO has asked for your perspective on whether or not to purchase the machinery.
After talking to the supplier and meeting with your Engineers and Financial Analysts, you've gathered the following pieces of data:
- Cost of Machine: $140,000
- Estimated Annual After Tax Cash Flow Savings: $60,000 (which may or may not grow)
- Estimated machinery life: 3-5 years (after which there will be zero value for the equipment and no further cost savings)
- You seem to recall that Dynamic's Finance organization recommends either a 10% or a 15% discount rate for all Cost Savings Projects
From your JWM I MBA, you know that you need to understand the project financials to ensure that this investment will be economically attractive to Dynamic Manufacturing's shareholders.
Calculate the Nominal Payback, the Discounted Payback, the Net Present Value and the IRR for each scenario, assuming:
A. Ann (A) recommends using the base assumptions above: 3 year project life, flat annual savings, 10% discount rate.
B. Bob (B) recommends savings that grow each year: 3 year project life, 10% discount rate and a 10% compounded annual savings growth in years 2 & 3. 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 3 in year.
C. Cassidy (C) believes we use a higher Discount Rate because of the risk of this type of project: 3 year project life, flat annual savings, 15% discount rate.
D. David (D) is convinced the machine will last longer than 3 years. He recommends using a 5 Year Equipment Life: 5 year project and savings life, flat annual savings, 10% discount rate. In other words, assume that the machine will last 2 more years and deliver 2 more years of savings.
In an MS Word document, in paragraph form, respond to the following questions:
1) Which person's scenario would you present to management and why? From a strictly financial (numbers) perspective, would you recommend this purchase to management?
2) In your opinion, which person's scenario is based on the most aggressive assumptions? If you were to select this scenario as the basis for your proposal, how would you justify the more aggressive assumptions?
3) In SIMPLE English (as in talking to a non-Finance and non-MBA person), explain why there is value to management in running all 4 of these scenarios.
4) Beyond financial measures, what other factors would you want to consider, before making a recommendation to management?
5) If you were the CEO, would you approve this proposal? Why or why not? Case Analysis 3 (Weight 40% of Total Assignment)
You are the General Manager at the Bicker, Slaughter, and Lynch Law Firm. There is an opportunity to buy out a small law firm that was just started by a young MBA/JD, and you believe the firm can be grown and become a lucrative part of your Firm.