Reference no: EM132635023

Problem 1: How to find the net present value (NPV).

Olivia, the head of Operations, is concerned that instead of stabilizing the supply chain, it will just add another process to be managed, and will distract from the core competencies the company currently has. She feels the company should focus on improving communication and supply chain management with its current vendor, and she feels confident he can negotiate a discount of 4% off of the annual outsourcing cost of $1,200,000 if she lets it be known they are considering taking over this step of the process. As there is little risk associated with Olivia's proposal due to no upfront capital requirements, a lower risk-free discount rate of 7% would be appropriate. Oliva feels that any price reductions from the current vendor will last for five years. (NOTE: because there is no "investment", the Payback and IRR metrics are not meaningful. Simply provide the NPV of the Savings cash flows).

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).