Word Count 1700–1900: The President Of EEC Recently Called A

Word Count 1700 1900the President Of Eec Recently Called A Meeting T

The President of EEC recently called a meeting to announce that one of the firm’s largest suppliers of component parts has approached EEC about a possible purchase of the supplier. The President has requested that you and your staff analyze the feasibility of acquiring this supplier. Based on the following information, calculate net present value (NPV), internal rate of return (IRR), and payback for the investment opportunity: EEC expects to save $500,000 per year for the next 10 years by purchasing the supplier. EEC’s cost of capital is 14%. EEC believes it can purchase the supplier for $2 million.

Answer the following: Based on your calculations, should EEC acquire the supplier? Why or why not? Which of the techniques (NPV, IRR, payback period) is the most useful tool to use? Why? Which of the techniques (NPV, IRR, payback period) is the least useful tool to use? Why? Would your answer be the same if EEC’s cost of capital were 25%? Why? Why not? Would your answer be the same if EEC did not save $500,000 per year as anticipated? What would be the least amount of savings that would make this investment attractive to EEC? Given this scenario, what is the most EEC would be willing to pay for the supplier? Prepare a memo to the President of EEC detailing your findings and showing the effects if: (a) EEC’s cost of capital increases (b) the expected savings are less than $500,000 per year (c) EEC must pay more than $2 million for the supplier.

Paper For Above instruction

1500 words, comprehensive analysis of the investment opportunity, detailed calculations of NPV, IRR, and payback period, and strategic recommendations for EEC.

Introduction

In today’s competitive business environment, strategic acquisitions can significantly enhance a firm's market position and operational efficiency. The recent approach by a major supplier of EEC offers an opportunity that warrants thorough financial analysis. The critical question is whether acquiring this supplier makes economic sense given the anticipated savings, cost of capital, and purchase price. This paper provides a detailed evaluation using key capital budgeting techniques—Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period—to determine the feasibility of this investment and offers strategic recommendations accordingly.

Financial Analysis and Calculations

Assumptions and Data

Based on the scenario, the following assumptions are used in the analysis:

• Annual savings from acquisition: $500,000
• Projected savings period: 10 years
• Cost of capital (discount rate): 14%
• Initial purchase cost: $2,000,000

Net Present Value (NPV)

NPV is the difference between the present value of cash inflows and outflows. It indicates whether the investment will generate value above the cost of capital. The formula used is:

NPV = ∑ (Cash flow / (1 + r)^t) - Initial Investment

Where r is the discount rate (14%), and t is each year from 1 to 10.

Calculating the present value of savings over 10 years:

PV of savings = $500,000 × [(1 - (1 + r)^-n) / r]

PV of savings = $500,000 × [(1 - (1 + 0.14)^-10) / 0.14] ≈ $500,000 × 5.759 ≈ $2,879,500

Thus, NPV = $2,879,500 - $2,000,000 = $879,500

Since the NPV is positive, the investment appears financially attractive.

Internal Rate of Return (IRR)

The IRR is the discount rate that equates the present value of cash inflows with the initial investment, i.e., where NPV = 0.

Using the annuity formula, IRR can be approximated by solving:

Initial Investment = PV of savings

$2,000,000 = $500,000 × [(1 - (1 + IRR)^-10) / IRR]

Through iterative calculation or financial calculator, IRR ≈ 20.4%.

Since IRR exceeds the cost of capital (14%), the project is considered acceptable from a return perspective.

Payback Period

Payback period is the time needed for cumulative cash inflows to recover initial investment:

Payback Period = Initial Investment / Annual Savings = $2,000,000 / $500,000 = 4 years.

The payback period of 4 years is within the 10-year savings horizon, indicating relatively quick recovery of investment.

Strategic Recommendations

Should EEC Acquire the Supplier?

Given positive NPV ($879,500), an IRR of approximately 20.4%, and a payback period of 4 years, the acquisition presents a financially sound opportunity under current assumptions. The investment would add value to EEC and improve operational efficiencies. However, these conclusions depend on the validity of the assumptions—particularly the annual savings and purchase price.

Most Useful Technique and Least Useful Technique

The NPV method is the most useful because it directly measures the expected value added to EEC, considering the time value of money. IRR provides insight into the project’s return relative to the cost of capital, but it can sometimes be misleading if used alone, especially in projects with non-conventional cash flows. The payback period, while simple, ignores the time value of money and cash flows beyond the payback horizon, making it less reliable as a sole decision criterion.

Impact of Increased Cost of Capital (25%)

If the cost of capital rises to 25%, the present value of savings decreases. Recalculating PV:

PV = $500,000 × [(1 - (1 + 0.25)^-10) / 0.25] ≈ $500,000 × 4.184 ≈ $2,092,000

NPV = $2,092,000 - $2,000,000 = $92,000, still positive but marginally so. The IRR would still be above 25%, roughly 22%, meaning the project remains acceptable but less attractive.

If Savings Were Less Than Expected

To find the minimum annual savings (S) that would make the project attractive (NPV ≥ 0):

S × [(1 - (1 + r)^-10) / r] ≥ $2,000,000

S × 5.759 ≥ $2,000,000

S ≥ $347,800

Therefore, savings must be at least approximately $347,800 annually for the project to break even economically.

Maximum EEC Would Be Willing to Pay

Using the maximum purchase price where NPV remains positive, it should not exceed the present value of the savings:

Maximum Price ≈ $2,879,500

Conclusion and Strategic Implications

Based on the comprehensive financial analysis, acquiring the supplier at $2 million is justified under current assumptions. The positive NPV, IRR exceeding the discount rate, and acceptable payback period support proceeding with the acquisition. Nevertheless, if the cost of capital increases or anticipated savings decline substantially, the attractiveness diminishes. EEC should consider negotiating the purchase price or restructuring the deal if conditions change favorably. Additionally, the sensitivity analysis underscores the importance of conservative estimates for savings and discount rates in strategic decision-making.

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