Sanford Company
MBA 655 - Corporate Finance - Major Project
(adapted and extended from MBA 650, Henry Singletary, to MBA 655, Andrew Root)
Evaluating Enterprise Solutions Incorporated (“ESI”) Growth Plans
Rachel Rodriguez was very inquisitive growing up. Rachel, like most children in
developed economies, enjoyed playing on the computer. Her curiosity went further than
normal. Rachel was in the habit of cracking open her laptop, computer and cellphone to
see how the electronics were connected and to understand how the devices worked.
Initially Rachel’s parents were not amused. Eventually they encouraged her interest in
electronics.
Years later Rachel enrolled in a computer class in high school and became certified in
Microsoft Office. During high school summers Rachel worked for a local computer store.
When business was slow the owner would teach her how computers worked. Rachel went
on to major in computer science at the University of Maryland. Her long-term desire was
to own her own computer consulting business, helping clients set up their computer
networks and servicing all their information technology (“IT”) needs.
After earning B.S. in Computer Science from the University of Maryland, Rachel got a
job at a local bank as an IT help desk technician. After five years at bank, Rachel started
her own computer consulting company. While Rachel’s computer consulting had been
successful, many of the company’s clients wanted to purchase the computer equipment
from the business as well. Recently Rachel’s Enterprise Solutions Inc (“ESI”) has begun
offering leased computer equipment as well as consulting services. ESI’s target market
was small businesses.
After graduating from Regent University with a MBA degree you took a job as a finance
analyst at ESI. Rachel believes that you have enough experience to help with the capital
udgeting decisions now facing ESI.
Rachel’s ESI had the following balance sheet and income statement for the year ending
December 31, 202x.
Rachel’s Enterprises Solutions Incorporated
Balance Sheet
As at December 31, 202x
ASSETS LIABILITIES
Cash $ 37,000 Accounts Payable $ 40,000
Marketable Securities 10,000 Wages Payable XXXXXXXXXX,800
Accounts Receivable 63,000 Taxes Payable 7,200
Uncollectible Accounts -2,000 Short-Term Note Payable 30,000
Inventory 74,000 Interest Payable 2000
Supplies 4,000 Unearned Revenue 20,000
Prepaid Insurance 7,500 Unearned Consulting Rev. XXXXXXXXXX5,000
Total Cu
ent Assets $193,500 Total Cu
ent Liabilities $ 115,000
Land $111,500 Long-Term Notes Payable $ 50,000
Equipment 217,000 Bonds Payable 100,000
Accumulated Depreciation -97,000 Mortgage Payable 350,000
Building 590,000 Total Long-Term Liabilities $500,000
Accumulated Depreciation -110,000
Intangible Assets 60,000 STOCKHOLDER EQUITY
Total Long-Term Assets $771,150 Capital Stock $100,000
Paid in Capital 140,000
Retained Earnings 110,000
Total Stockholders Equity $350,000
Total Assets $965,000 Total Liabilities & Equity $965,000
Rachel’s Enterprises Solutions Incorporated
Income Statement and Segment EBITDA
For the 12 Months Ending December 31, 202x
Equipment Sales Revenue 1,333,440
Consulting Service Revenue (Online Help XXXXXXXXXX,000
Total Revenue 1,783,440
Cost of Goods Sold XXXXXXXXXX,450
Selling, General & Administrative XXXXXXXXXX,820
Depreciation & Amortization XXXXXXXXXX,665
Earnings Before Interest and Tax (EBIT XXXXXXXXXX,505
Interest XXXXXXXXXX,576
Earnings Before Tax (EBT XXXXXXXXXX,929
Tax XXXXXXXXXX,686
Net Income XXXXXXXXXX,243
Shares Outstanding 14,000
Earnings Per Share XXXXXXXXXX
Equipment sales EBITDA XXXXXXXXXX,720
Consulting Online Help EBITDA XXXXXXXXXX,450
Total EBITDA XXXXXXXXXX,170
Rachel is putting together a growth plan for ESI. She is evaluating whether to
substantially invest in company owned equipment, and whether to outsource her online
services personnel to a call center in New Dehli, India. Rachel has asked for your
analysis of the following two decisions facing ESI:
1. Equipment Purchase - ESI may decide to purchase outright additional computer
equipment. ESI can continue to lease equipment from hardware vendors. Such a
status quo decision comes with known margins and profitability metrics. The
status quo is embodied in the income statement and balance sheet reported in
202x data given above. Rachel believes adding owned equipment to its existing
leasing business will enable ESI to more fully utilize their fixed assets, grow
faster and provide more customized services to a larger group of future clients.
Rachel is proposing to purchase $500,000 of additional IT equipment. The
equipment would be installed and prepared for use in the cu
ent year. When fully
utilized the equipment would generate asset turnover of approximately 2x gross
investment. It would likely take four years to reach full utilization. The useful life
of equipment for accounting and tax purposes is 10 years. However, due to rapid
life cycles in enterprise technology, after six years Rachel expects to sell the
equipment for 10% of initial cost. The EBITDA (operating income plus
depreciation and amortization) margin of business done with owned equipment is
1.1x the margin of business done with leased equipment.
2. Outsourcing online consultants - Rachel may move her entire online service team
to India. As she has tried to re-sign existing clients and win new business Rachel
has been feeling pricing and margin pressure. For the time being Rachel has only
e-signed or sought new business that matches her cu
ent margin profile. Rachel
expects to be able to maintain the status quo in the online services business for
several more years. However, for the most part Rachel’s regional and national
competitors have outsourced online support to low-cost countries. ESI’s higher
cost structure limits the future growth of ESI services. ESI’s five full time online
consultants each make $60,000 per year. The online segment cost of goods sold is
a little more than the $300,000 paid to the consultants in the most recent year.
Consulting EBITDA is approximately $147,450. If ESI does not outsource its
consultants it is estimated consultant margin dollars will remain about flat for the
next several years. For comparison, online consultants in India make
approximately $30,000 per year, growing at 10% per year. In the first year after
moving to India Rachel expects consulting EBITDA margins dollars to be the
same as in the US. However, in years 2 through 10 consulting revenue should
grow by 20% per year, while the increase labor cost and productivity gains of
India employees should just about offset. This means ESI could maintain its
cu
ent consulting EBITDA margin on a growing revenue base. Uncertainty in
technology life cycles means Rachel doesn’t think it is reasonable to plan an
online services business beyond 10 years into the future. To make the move to
India, ESI would pay the cost of a fairly generous severance. It is expected US
employees would receive a package valued at 50% of annual compensation. ESI
would sell five U.S. based computer terminals and desks for $8000. The setup
costs in India, including new office space, equipment and telecom infrastructure is
$100,000. The setup costs will be amortized over 10 years. For conservatism,
after 10 years ESI assumes zero recovery on any office furniture, and no future
lease liabilities.
Additional Capital Budgeting Assumptions:
Marginal and average corporate tax rate of 21%.
Pretax cost of bank bo
owing is 5%.
As a private firm ESI has an internally defined required return on equity of 10%.
ESI’s banks charge a 2% premium for international investments. The required equity
eturn should also be charged a risk premium over domestic investments.
ESI expects to maintain the ratio of equity and long-term liabilities shown in the 202x
alance sheet.
The reinvestment rate earned on idle cash is 3%.
Required
1. Calculate the capital budgeting decision metrics for the proposed expansion in
ESI owned computer equipment. Calculate each of NPV, IRR, MIRR, Payback
and Profitability Index. Show all calculations including initial outlay, annual
differential cash flows, terminal value, and weighted average cost of capital. (30
points).
2. In addition to the capital budgeting calculations, discuss at least three important
qualitative issues associated with the proposed purchase of additional computer
equipment. (10 points).
3. Calculate the capital budgeting decision metrics for the proposed outsourcing of
ESI’s online help desk to New Dehli, India. Calculate each of NPV, IRR, MIRR,
Payback and Profitability Index. (30 points).
4. Discuss the challenging issues Rachel may create for ESI by outsourcing online
help services to an overseas location such as India. In the discussion include any
iblical moral principles that apply to ESI’s decision. (10 points).
5. Make a definitive recommendation to Rachel. Should ESI make one, both or
neither investment? Base your recommendation on your calculations and
qualitative analysis. Include in your recommendation the two or three most
critical elements of your qualitative reasoning. ESI’s future, and your career, are
in part dependent on the quality of your advice. (10 points).
6. Think now about your own existing business or a business you may start in the
future. It is likely you have presented a strategic plan for this business in the
capstone class, MBA 679. Discuss how you could use capital budgeting analysis
from this class, and the major project, to make investment decision for your
existing or proposed business. (10 points).
Submit all calculations in a single excel file. Prose may also be included in an excel file,
or it may be submitted in a separate word document.
MBA 655 - Corporate Finance - Major Project
Evaluating Enterprise Solutions Incorporated (“ESI”) Growth Plans
Sanford Company
MBA 655 - Corporate Finance - Major Project
(adapted and extended from MBA 650, Henry Singletary, to MBA 655, Andrew Root)
Evaluating Enterprise Solutions Incorporated (“ESI”) Growth Plans
Rachel Rodriguez was very inquisitive growing up. Rachel, like most children in
developed economies, enjoyed playing on the computer. Her curiosity went further than
normal. Rachel was in the habit of cracking open her laptop, computer and cellphone to
see how the electronics were connected and to understand how the devices worked.
Initially Rachel’s parents were not amused. Eventually they encouraged her interest in
electronics.
Years later Rachel enrolled in a computer class in high school and became certified in
Microsoft Office. During high school summers Rachel worked for a local computer store.
When business was slow the owner would teach her how computers worked. Rachel went
on to major in computer science at the University of Maryland. Her long-term desire was
to own her own computer consulting business, helping clients set up their computer
networks and servicing all their information technology (“IT”) needs.
After earning B.S. in Computer Science from the University of Maryland, Rachel got a
job at a local bank as an IT help desk technician. After five years at bank, Rachel started
her own computer consulting company. While Rachel’s computer consulting had been
successful, many of the company’s clients wanted to purchase the computer equipment
from the business as well. Recently Rachel’s Enterprise Solutions Inc (“ESI”) has begun
offering leased computer equipment as well as consulting services. ESI’s target market
was small businesses.
After graduating from Regent University with a MBA degree you took a job as a finance
analyst at ESI. Rachel believes that you have enough experience to help with the capital
udgeting decisions now facing ESI.
Rachel’s ESI had the following balance sheet and income statement for the year ending
December 31, 202x.
Rachel’s Enterprises Solutions Incorporated
Balance Sheet
As at December 31, 202x
ASSETS LIABILITIES
Cash $ 37,000 Accounts Payable $ 40,000
Marketable Securities 10,000 Wages Payable XXXXXXXXXX,800
Accounts Receivable 63,000 Taxes Payable 7,200
Uncollectible Accounts -2,000 Short-Term Note Payable 30,000
Inventory 74,000 Interest Payable 2000
Supplies 4,000 Unearned Revenue 20,000
Prepaid Insurance 7,500 Unearned Consulting Rev.