Capital Budgeting:

With the aid of capital budgeting techniques, the company can decide whether the company
should go for a project or not or the investment made by the company is worthy or not. In
order to do that, Stryker Corporation needs to analyze the initial investment along with the
cash in-flows and out-flows of the company with respect to the specific project. Because of
the limited budget and scarce resources, the company needs to use techniques provided in
capital budgeting to find an alternative with maximum return. This can be done through
calculating Net Present Value (NPV), Payback Period, Discounted Cash Flow (DCF) and
Internal Rate of Return (IRR).
Financial and operating data:
Exhibit 1 provides financial and operating data that will help to estimate the projected net
income of Stryker Corporation. Projections have been done in an excel spreadsheet to
calculate the discounted cash flows of the company. In order to make projections,
horizontal analysis has been done that is based on making projections by analyzing the
increase or decrease percentage over the period. Net sales of the company have increased
on an average rate of 15% over the period of three years; thus, projections for net sales are
done on the growth rate of 15%.
Gross profit of the company has increased with an average growth rate of 14% and by the
end of 2009; the gross profit of the company will reach to $4.7 million. Further, research
and development expense of the Stryker Corporation has increased to 8% from 2000 to
2002; thus, total R&D expense of the company will be $2.6 million in 2009. By making all
the projections of the financial and operating data given, projected net earnings of the
company have been calculated and is shown in the spreadsheet attached.
Discounted Cash Flows (DCF):
In order to find the discounted cash flows of the company, gross profit of the company has
been projected for six years out of which taxes have been deducted with a tax rate of 35%
given in the data. After that, depreciation has been added back, and changes in the capital
expenditure have been subtracted from the net earnings. After that, changes in net working
capital have been subtracted to find free cash flows of the Stryker Corporation. After
calculating free cash flow of the firm, it has been discounted with the hurdle rate of 15%
over the period of five years to obtain the present value of the project.
Net Present Value:
By using net present value technique, the cash flows of the company have been discounted
over the period of six years. If the net present value of the project is greater than zero then
the implementation of the project is recommended as it is used to compare the present value
of the dollar with the value of the dollar in the future. As per the calculations done in a
spreadsheet, NPV of the project is found to be $2.8 million that is positive and indicates
that the cash generated from in-sourcing will be positive; thus, it should be implemented
because in-sourcing PCBs will be cheaper for the company to implement.
Internal Rate of Return:
From internal rate of return, the management of the company identifies the rate of return
that a company will be able to get from its proposed project if the net present value of the
company becomes zero. In order to find the internal rate of return, free cash flows of the
company has been discounted by assuming a discount factor of 10% that makes net present
value equal to zero.
Payback Period:
Payback period technique describes companies to analyze the time that is required to cover
its initial investment made in the project. It is obvious that a project with the lowest
payback period will be most preferable. Payback period for the in-sourcing project is found
to be 3.87 years that means the Stryker Corporation will cover its initial investment and
will reach its breakeven point by the end of 2005. After that, the company will start
generating positive cash flows from the in-sourcing project.
Conclusion:
There are several risks involved with option three for the company like in-sourcing
manufacturing will require Stryker Corporation to hire a skilled worker that can work
efficiently to manufacture PCBs. In addition to that, the company needs to train its current
employees according to the new strategy that will be implemented in the manufacturing
facility. Moreover, the company needs to hire skilled workers along with experience
professionals that can run the factory smoothly and efficiently