MEMORANDUM TO:Board of Directors Stryker Corporation DATE:July 15th, 2011 SUBJECT:In-sourcing PCBs Project Recommendation The purpose of this memo is to disclose the business evaluation for the three proposed options regarding PCBs sourcing strategy. The analyzed options are: 1. To maintain the current basic sourcing policy but with improvements in the acquiring methodology of key materials. 2. To establish of a partnership with a single supplier to improve quality. 3.
To establish a manufacturing facility to in-source the production of PCBs. This option will allow the company to reach higher control and reliability over the manufacturing of such components.
The analysis conducted, estimates the net present value, internal rate of return, payback period and discounted payback period of the option of implementing a manufacturing facility (option #3). This option requires considerable outlay to fund the construction of the plant and to procure owned equipment.
The analysis was based on the assumption of constant level of sales and a decrease of purchases costs in exchange of higher manufacturing costs.
Additionally, there is a benefit in terms of longer accounts payable turnover, increasing from 30 to 120 days due to new negotiations with suppliers. All of the above facts lead to different tax impacts such as: The new capital expenditure leads to a higher depreciation expense which is deductible from tax payments, as well as the new manufacturing costs; accordingly, this result in a lower taxation base that causes a lower tax payment.
On the other hand, since the company has lower purchases, this lower production cost increases the taxation base that lead to a higher tax payment.
The company cash flow for the analysis under option three is composed by the incremental impacts derived from the in-sourcing of the manufacturing process. The outflows for the seven year period are the capital expenditure $6,3M, the new manufacturing costs $ 55M and the net tax effect $ 4M. There are also positive cash inflows coming from the decrease in purchases from third parties $ 69,3M and there is a working capital positive effect due to he extension in the payment period from 30 to 120 days $ 0,8M. For detailed information see Exhibit 1. The results from 2004 to 2009 lead to the following economic evaluation As it is shown the NPV is negative, meaning that the net cash flow for the period analyzed is not enough to breakeven the outlays. Also, it is shown that the IRR is lower than the discount rate, meaning that the project yield is lower than the opportunity cost, therefore it would be better to invest the funds elsewhere.
Regarding the payback period, it goes up to four years to breakeven; however, discounted payback period (see Exhibit 2), requires more than six years, beyond the analyzed period. In conclusion, the project evaluation suggests that Stryker Corporation should reject the project of building a facility to manufacturing PCBs, as all the economic evaluation indicators are adverse to the project: negative cash flow, lower IRR than discount rate, long payback period and discounted payback.
Our recommendation is to implement option two: joint a partnership with a sole supplier, which does not compromise capex outlays and still can provide outcomes with high quality and reliability, having no financial risks for the company as the partner is assuming the required capex and Stryker is still receiving the accounts payable turnover benefits. Exhibit 1. Total Cash Flow of Project # 3 Exhibit 2. Discounted Cash Flow to Compute Discounted Payback Period Exhibit 3. Depreciation calculations
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