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Dave Wang and Eva Welch are facing an important decision.




Dave Wang and Eva Welch are facing an important decision. After having discussed different;financial scenarios into the wee hours of the morning, the two computer engineers felt it was;time to finalize their cash flow projections and move to the next stage decide which of two;possible projects they should undertake.;Both had a bachelor degree in engineering and had put in several years as maintenance engineers;in a large chip manufacturing company. About six months ago, they were able to exercise their;first stock options. That was when they decided to quit their safe, steady job and pursue their;dreams of starting a venture of their own. In their spare time, almost as a hobby, they had been;collaborating on some research into a new chip that could speed up certain specialized tasks by;as much as 25%. At this point, the design of the chip was complete. While further;experimentation might improve the performance of their design, any delay in entering the market;now may prove to be costly, as one of the established players might introduce a similar product;of their own. The duo knew that now was the time to act if at all.;They estimated that they would need to spend about $1,000,000 on plant, equipment and;supplies. As for future cash flows, they felt that the right strategy at least for the first year would;be to sell their product at dirt-cheap prices in order to induce customer acceptance. Then, once;the product had established a name for itself, the price could be raised. By the end of the fifth;year, their product in its current form was likely to be obsolete. However, the innovative;approach that they had devised and patented could be sold to a larger chip manufacturer for a;decent sum. Accordingly, the two budding entrepreneurs estimated the operating cash flows for;this project (call it Project A) as follows;Year;Project A;Expected Cash flows ($);0;1;2;3;4;5;(1,000,000);50,000;200,000;600,000;1,000,000;1,500,000;An alternative to pursuing this project would be to sell their innovative chip design to one of the;established chip makers. This way, they would receive an upfront payment. But the amount;would be relatively small perhaps around $200,000 as neither their product nor their;innovative approach had a track record.;They could then invest in some plant and equipment that would test silicon wafers for zircon;content before the wafers were used to make chips. Too much zircon would affect the long-term;performance of the chips. The task of checking the level of zircon was currently being performed;by chip makers themselves. However, many of them, especially the smaller ones, did not have;the capacity to permit 100% checking. Most tested only a sample of the wafers they received.;Dave and Eva were confident that they could persuade at least some of the chip makers to;outsource this function to them. By exclusively specializing in this task, their little company;would be able to slash costs by more than half, and thus allow the chip manufacturers to go in for;100% quality check for roughly the same cost as what they were incurring for a partial quality;check today. The life of this project too is expected to be only about five years.;The initial investment for this project is estimated at $ 1,100,000. After taking into account the;sale of their patent, the net investment would be $900,000. As for the future, Eva and Dave were;pretty sure that there would be sizable profits in the first year. But thereafter, the zircon content;problem would slowly start to disappear with advancing technology in the wafer industry.;Keeping this in mind, they estimate the future cash inflows for this project (call it Project B) as;follows;Year;Project B;Expected Cash flows ($);0;1;2;3;4;5;($900,000);650,000;650,000;550,000;300,000;100,000;Eva and Dave now need to make their decision. For purposes of analysis, they plan to use a;required rate of return of 20% for both projects. Ideally, they would prefer that the project they;choose have a payback period of less than 3.5 years and a discounted payback period of less than;4 years.;Below are the results of the analysis they have carried out so far;Metrics;Payback period (in years);Discounted payback period (in years);Net Present Value (NPV);Internal Rate of Return (IRR);Profitability Index;Project A;3.15;3.98;$612,847.22;35.93%;1.61;Project B;1.38;1.79;$596,206.28;55.07%;1.66;Modified Internal Rate of Return (MIRR);32.04%;32.84%;One of the concerns that Eva and Dave have is regarding the reliability of their cash flow;estimates. All the analysis in the table above is based on expected cash flows. However, they;are both aware that actual future cash flows may be higher or lower.;Assignment Questions;Note: Please keep your responses brief and to the point. Your answers must be typed up in;double space, Times New Roman 12 font, with 1.25-inch margins, and uploaded into the D2L;dropbox as a Word or pdf file. I expect your submission to be between two to four pages in;length.;Please name your file as follows: FirstName.LastName.Fin390-sectionNumber, for example;John.Smith.Fin390-XX.docx.;The assignment counts for 5% of your overall grade in this course, and will be scored out of 100;points. 20 of these points will be based on presentation and clarity of writing (including;correctness of grammar). The remaining 80 points are distributed across the 6 questions as;indicated below.;1. Briefly, summarize the key facts of the case and identify the problem being faced by our;two budding entrepreneurs. In other words, what is the decision that they need to make?;(10 points);2. List the different approaches that can be used to solve this problem. In other words, what;are the various criteria or metrics that can be used to help make this decision? (10 points);3. Rank the projects based on each of the following metrics: Payback period, Discounted;payback period, NPV, IRR, Profitability Index, and MIRR. (10 points);4. Dave believes that the best approach to make the decision is the NPV approach.;However, Eva is not so sure that ignoring the other metrics is a good idea. Which of the;approaches or metrics would you propose? In other words, would you prefer one or more;of these approaches over the others? Explain why. (20 points);5. Which of these projects would you recommend? Explain why. (10 points);6. Briefly state the limitations of the approach you used in making this decision, and outline;what further analysis you would recommend. (20 points)


Paper#29863 | Written in 18-Jul-2015

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