Cost-Benefit Analysis

JWI 530: Financial Management I
Assignment 2

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be copied, further distributed, or otherwise disclosed, in whole or in part, without the expressed written permission of Strayer University.
This document is subject to change based on the needs of the class.

JWI 530 – Assignment 2 (1244) Page 1 of 5

• The estimated purchase price for the equipment required to move the operation in-house would be
$950,000. 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 $42,000 per year starting in year 0 and through all
years of the project to support production as raw materials will be required in year 0 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 $1,800,000. The estimated
cash flow savings of bringing the process in-house is 18% or annual savings of $324,000. 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 $60,000. (i.e., the terminal value).

Cost-Benefit Analysis
Parts A and B: Due Monday, 9:00 am (eastern), Week 10 (25% of Final Grade)

Overview

In this assignment, you will take on the role of a senior member of the finance team assigned to lead the
investment committee of a pollution control equipment manufacturer. Your team is evaluating a “make-versus-
buy” decision that has the potential to improve the company’s competitiveness, but which requires a significant
capital investment in new equipment. The assignment is organized into two parts:

Part A: Data calculations based on the information in the scenarios

Part B: Recommendations based on the calculations

Opportunity Details

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 positively impact 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 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:

JWI 530: Financial Management I
Assignment 2

© Strayer University. All Rights Reserved. This document contains Strayer University confidential and proprietary information and may not
be copied, further distributed, or otherwise disclosed, in whole or in part, without the expressed written permission of Strayer University.
This document is subject to change based on the needs of the class.

JWI 530 – Assignment 2 (1244) Page 2 of 5

Input from Stakeholders

As part of your research, you have sought input from several stakeholders. Each has raised important
points to consider in your analysis and recommendation. Some of the points and assumptions are purely
financial. Others touch on additional concerns and opportunities.

1. Amber, your colleague from Accounting, recommends using the base assumptions above: 5-year

project life, flat annual savings, and an 11% discount rate. Amber does not feel the equipment will
have any terminal value due to advancements in technology.

2. Brian 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 an 8% annual savings growth in years 2 through 5. In other
words, instead of assuming savings stay flat, assume that year 2 will be 108% of year 1, year 3
will be 108% of year 2, and so on. Brian feels that the stated terminal value of $60,000 is
reasonable and uses it in his calculations.

3. Caleb from Engineering believes we should use a higher Discount Rate because of the risk of this

type of project. As such, he is recommending a 5-year project life and flat annual savings. Caleb
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. As an engineer, Caleb feels that the stated terminal value is low based on her experience and
recommends a $75,000 terminal value.

4. Dylan, the Product Manager, is convinced the new capability will allow better quality control and

on-time delivery and that it will last longer than 5 years. He recommends using a 7 Year Equipment
Life (which means a 7-year project and that savings will continue for 7 years), flat annual savings,
and a 12% discount rate. In other words, assume that the machine will last 2 more years and
deliver 2 more years of savings. Dylan also feels the equipment will have an estimated terminal
value of $30,000 at the end of its 7-year useful life as it will be utilized longer, thus having less
value at the end of the project and savings.

5. Eva, 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 he feels confident he can negotiate a discount of 4% off
the annual outsourcing cost of $1,800,000 if she lets it be known they are considering taking over
this step of the process. As there is little risk associated with Eva’s proposal due to no upfront capital
requirements, a lower risk-free discount rate of 6% would be appropriate. Eva feels that any price
reductions from the current vendor will last for five years. (NOTE: because there is no “investment,”
the Nominal Payback, Discounted Payback, and IRR metrics are not meaningful. Simply provide the
NPV of the annual savings cash flows).

JWI 530: Financial Management I
Assignment 2

© Strayer University. All Rights Reserved. This document contains Strayer University confidential and proprietary information and may not
be copied, further distributed, or otherwise disclosed, in whole or in part, without the expressed written permission of Strayer University.
This document is subject to change based on the needs of the class.

JWI 530 – Assignment 2 (1244) Page 3 of 5

PART A: Data Calculations

Using the data presented above (and ignoring the extraneous information), for this profit and supply
chain improvement project, calculate each of the following (where applicable):

• Nominal Payback

• Discounted Payback

• Net Present Value

• Internal Rate of Return

Scenario Nominal
Payback

Discounted
Payback

Net Present
Value

Internal Rate of
Return

#1: Amber

#2: Brian

#3: Caleb

#4: Dylan

#5: Eva N/A N/A N/A

Submission Requirements

Present your calculations and results either in an Excel Spreadsheet or in Word (using tables and headers
to organize the information in a way that is clear and easy to read).

Note: Be sure to show your detailed calculations. If you get something wrong, you may still be able to get
partial credit.

JWI 530: Financial Management I
Assignment 2

© Strayer University. All Rights Reserved. This document contains Strayer University confidential and proprietary information and may not
be copied, further distributed, or otherwise disclosed, in whole or in part, without the expressed written permission of Strayer University.
This document is subject to change based on the needs of the class.

JWI 530 – Assignment 2 (1244) Page 4 of 5

Part B: Recommendations

After completing the calculations for all scenarios, create a brief memo to the CEO outlining your
committee’s recommendations. You may organize the memo as you see fit, but it must include the following:

• A clear opening statement of your recommendation for or against the project.

• A brief synopsis of the processes and factors that led to your recommendations.

o What information did you gather, and how did you get it?

o From whom did you seek input, and why?

• A summary of the strategic benefits and risks in pursuing (or not pursuing) this project, including:

o Highlights of the main data points that support your position

o Acknowledgment of the data points that oppose your argument

o Identification of open/unresolved items

• Identification of the scenario that, from a purely financial perspective, represents the most accurate
estimate of the anticipated results and your rationale as to why.

• Identification of non-financial elements that need to be considered for the recommended scenario.

• Any assumptions in project economics can have a significant impact on the result. Identify 3 financial
elements/assumptions in your analysis that would make this project financially unattractive. Be as
transparent and candid as possible. What would have to be true for this to be a bad investment?

• A summary restating your recommendation and key action items.

Submission Requirements

• Your memo should be no more than 2 pages, single-spaced, using 10- or 12-point font.
• Focus on the rationale for your recommendations.
• Include key numbers to support your recommendations but do not re-present all your calculations.

JWI 530: Financial Management I
Assignment 2

© Strayer University. All Rights Reserved. This document contains Strayer University confidential and proprietary information and may not
be copied, further distributed, or otherwise disclosed, in whole or in part, without the expressed written permission of Strayer University.
This document is subject to change based on the needs of the class.

JWI 530 – Assignment 2 (1244) Page 5 of 5

RUBRIC

25% of Course
Grade Assignment 2

Criteria Honors High Pass Pass Low Pass Unsatisfactory

1. Correct answers
for the investment
recommendation
scenarios

2.
3.
4. Weight: 25%

Demonstrates
exemplary
understanding by
calculating 15 or
more answers
correctly.

Demonstrates a
high level of
understanding by
calculating 13 to
14 answers
correctly.

Satisfactorily
demonstrates
understanding by
calculating 11 to
12 answers
correctly.

Partially
demonstrates
understanding by
calculating 9 to
10 answers
correctly.

Does not
demonstrate
understanding,
either by not
submitting or by
calculating 8 or
fewer answers
correctly.

5. Show work for
calculation for the
investment
recommendation
scenarios

6.
7.
8. Weight: 20%

Fully and
completely
shows
process, order
and calculation of
the required
metrics.

Shows process,
order and
calculation that
mostly supports
generation of the
required metrics.

Demonstrates
basic level of
understanding of
process, order
and
calculation, but
may have some
errors.

Incorrectly
demonstrates
process, order
and calculation
and has many
errors.

Does not show
work and/or has
significant errors
and shortcomings
of process, order
and calculation of
metrics.

3. Analyze the
investment
opportunity
leveraging the
supplied data
sets, and
provided clear,
well-reasoned
recommendations
to the CEO.

Weight: 45%

Provides
exemplary
analysis and
recommendations
addressing all
required memo
components and
all 5 options;
includes
additional insights
drawing on
learning from
outside sources
demonstrating
excellent business
sense.

Provides excellent
analysis and
recommendations
addressing all
required memo
components and
all 5 options.

Provides good
analysis and
recommendations
addressing at
least 4 of the
required memo
components and
options.

Provides minimal,
basic analysis and
recommendations
addressing 3 or
fewer of the
required memo
components and
options.

Does not submit, or
incompletely
analyzes the
investment options
and does not
address the key
questions or
explain
recommendations.

4. Professionally
communicates
with clear writing;
concise and free
of mechanical
errors.

Weight: 10%

Written
communication is
excellent;
concisely and
clearly expresses
recommendations
in an exemplary
manner that
rationally and
logically develops
the topics; free of
mechanical
errors.

Written
communication
flows well;
concisely and
clearly expresses
recommendations
in a manner that
rationally and
logically develops
the topics; there
are a few
mechanical
errors.

Written
communication
flows well but
lacks conciseness
or clarity in
places; assertions
and conclusions
are generally
justified and
explained;
contains several
minor
grammatical
errors.

Written
communication is
basic; fails to
clearly connect
conclusions and
assertions to data;
has several
mechanical errors
making parts of
the text difficult to
understand.

Written
communication
does not flow,
and/or fails to
justify or express
recommendations;
multiple
mechanical errors;
much of the
communication is
difficult to
understand.