Futronics Inc Is A 2 Billion-Dollar Firm That Sells Communic ✓ Solved
Futronics Inc Is A 2 Billion Firm That Sells Communications
Futronics Inc. is a $2 billion firm that sells communications services. Founded in 1937, Futronics has provided consumer products, as well as government systems and services, for well over half a century. Due to a sharp increase in competition, flattened sales, and external economic conditions, Futronics is implementing a corporate overhead reduction program. The proposal is to replace the company’s central office stores with outside vendors. The investment will cost $1,000,000 and yield incremental cash flows of $450,000 in year one (1), $350,000 in year two (2), $300,000 in year three (3), and $250,000 in year four (4). There is no salvage value of the asset, and the firm has a cost of capital of 8%. Write a two to three (2-3) page paper in which you: Calculate the net present value, internal rate of return, and simple payback. Next, determine the effect that each of the three (3) values will have on the company. Explain one to two (1-2) investment gains that the company could achieve by outsourcing the central office functions. Focus on the company’s potential to reduce overhead and still maintain or even improve the quality of its products. Discuss one (1) capital budgeting method that would be most effective for the company. Next, discuss one (1) capital budgeting method that would have the least value for the company as compared to others. Provide a rationale for your response. Use at least one (1) quality reference. Note: Wikipedia and similar Websites do not qualify as academic resources.
Paper For Above Instructions
Futronics Inc. is facing critical challenges due to increased competition, stagnant sales, and evolving economic conditions. In response, the company is initiating a corporate overhead reduction program that involves outsourcing its central office functions. This paper will analyze the financial viability of this initiative through net present value (NPV), internal rate of return (IRR), and simple payback period calculations. Additionally, it will discuss the advantages of outsourcing and evaluate capital budgeting methods suitable for Futronics.
Financial Analysis
Calculating Net Present Value (NPV)
The net present value is calculated by discounting future cash flows back to their present value and subtracting the initial investment. The cash flows provided for Futronics Inc. are:
- Year 1: $450,000
- Year 2: $350,000
- Year 3: $300,000
- Year 4: $250,000
The formula for NPV is:
NPV = Σ (Cash Flow / (1 + r)^t) - Initial Investment
Where:
- r = discount rate (cost of capital)
- t = year of cash flow
Substituting in the values:
NPV = ($450,000 / (1 + 0.08)^1) + ($350,000 / (1 + 0.08)^2) + ($300,000 / (1 + 0.08)^3) + ($250,000 / (1 + 0.08)^4) - $1,000,000
NPV = ($416,667 + $302,325 + $238,610 + $185,187) - $1,000,000
NPV = $1,142,789 - $1,000,000 = $142,789
This positive NPV indicates that the investment is financially viable.
Calculating Internal Rate of Return (IRR)
The internal rate of return is the discount rate that makes the NPV equal to zero. Using a financial calculator, the IRR for the cash flows is estimated to be approximately 12.26%. This represents a return on the investment higher than the company’s cost of capital of 8%, which is favorable.
Calculating Simple Payback Period
The payback period is calculated by determining how long it takes for the initial investment to be recovered from the cash inflows. The cumulative cash flows for Futronics are:
- End of Year 1: $450,000
- End of Year 2: $800,000 ($450,000 + $350,000)
- End of Year 3: $1,100,000 ($800,000 + $300,000)
The investment of $1,000,000 is fully recovered by Year 3:
Payback Period = 2 + ($1,000,000 - $800,000) / $300,000 = 2 + 0.67 = 2.67 years
Effect of Financial Metrics on the Company
The positive NPV of $142,789 suggests that outsourcing can contribute positively to Futronics' overall value. An IRR of 12.26%, exceeding the company's 8% cost of capital, indicates that outsourcing is a profitable investment. The payback period of 2.67 years shows that the company will recover its initial investment in a reasonable timeframe, minimizing risk.
Investment Gains from Outsourcing
Outsourcing central office functions can provide Futronics with several investment gains. First, it can lead to significant cost savings by reducing overhead expenses, as outsourced vendors typically operate at lower costs. This allows Futronics to reallocate resources to critical areas such as product development or marketing. Second, outsourcing can improve operational efficiency, as specialized vendors may offer superior services and technologies, leading to enhanced product quality. This strategic move may help maintain or elevate the company's market position amid substantial competition.
Capital Budgeting Methods
Most Effective Method
The most effective capital budgeting method for Futronics is NPV due to its comprehensive approach to evaluating investment profitability. It considers the time value of money, which is crucial for making long-term decisions in a competitive environment. NPV provides a clear picture of how much value an investment will add to the company, facilitating informed decision-making.
Least Valuable Method
Conversely, the least valuable method may be the payback period approach. While it provides insights into the time required for cash recovery, it disregards cash flows beyond the payback year and fails to account for the time value of money. This limitation could lead to suboptimal investment decisions, especially in scenarios with longer-term returns, like outsourcing central office functions.
Conclusion
In conclusion, Futronics Inc. stands to benefit from outsourcing its central office functions, as indicated by the positive financial metrics calculated. The NPV, IRR, and payback period all suggest that this strategic move can enhance the company’s financial standing while improving operational efficiency and product quality. Employing NPV as a capital budgeting method ensures that Futronics makes informed decisions that align with its long-term growth objectives.
References
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