BioCom, Inc.: Part 1 BioCom was founded in 1993, when several scientists and eng
ID: 2788814 • Letter: B
Question
BioCom, Inc.: Part 1 BioCom was founded in 1993, when several scientists and engineers at a large fiber-optic-cable company began to see that optical fiber for the telecommunications industry was becoming a cheap commodity. They decided to start their own firm, which would specialize in cutting-edge applications for research in the life sciences and medical instruments. BioCom is now one of the leading firms in its niche field. BioCom’s management attributes the firm’s success to its ability to stay one step ahead of the market’s fast-changing technological needs. Almost as important is BioCom’s ability to select high-value-added projects and avoid commercial disasters. Over lunch, BioCom’s director of research and development (R&D) mentioned to the CFO that one of his best young scientists had recently left the company because his line manager had rejected his project. Although not a pattern, R&D had experienced similar losses in the past. The two executives discussed the problem and agreed that if the R&D people understood the selection process better, they might come up with more commercially viable projects and understand the project’s financial implications. The CFO has asked his assistant, Jane Donato, to prepare a retreat for the R&D department to explain the company’s project selection procedures. Jane is encouraged by the thought that this group will have no trouble in following the math. BioCom’s standard capital request form includes a narrative description of the project and the customer need that the company must fulfill. If the request originates with R&D, it then goes to the marketing department for a preliminary sales forecast and then to the production manager and cost analysts for cost estimates. If a proposal shows promise after these steps, it goes to the CFO, who has a staff member enter the data into a spreadsheet template. The template computes payback, discounted payback, net present value, internal rate of return, and modified internal rate of return. BioCom uses net present value as its primary decision criterion, but company executives believe that the other statistics provide some useful additional perspectives. To explain BioCom’s capital budgeting techniques, Jane has decided to present the cash flows from two recent proposals: the nano test tube project and the microsurgery kit project. All figures are in thousands of dollars: Time of Cash Flow Nano Test Tubes Microsurgery Kit Investment -$11,000 -$11,000 Year 1 2,000 4,000 Year 2 3,000 4,000 Year 3 4,000 4,000 Year 4 5,000 4,000 Year 5 7,000 4,000 Help Jane answer the following questions. Question: Compute the internal rate of return (IRR) for each project.
Explanation / Answer
To compute the IRR for each of the project lets look at the excel below:
The nano test tube project
The microsurgery kit project
Years
Cash flows
Cashflows
0
-11000
-11000
1
2000
4000
2
3000
4000
3
4000
4000
4
5000
4000
5
7000
4000
IRR
20.970%
23.919%
The IRR for the nano test tube project is 20.970%
and the IRR for the microsurgery kit project is 23.919%
Comparing the two project with higher IRR is more attractive and should be accepted thus given in this case to make a decision we would select the microsurgery kit project.
The nano test tube project
The microsurgery kit project
Years
Cash flows
Cashflows
0
-11000
-11000
1
2000
4000
2
3000
4000
3
4000
4000
4
5000
4000
5
7000
4000
IRR
20.970%
23.919%
We can also calculate IRR in the financial calculator by inserting respective Cashflows and by pressing CPT and then I/YRelated Questions
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