DUE IN 4HRS

FIN 319 – Case #2

Capital Budgeting – New Product Decision

Precision Castparts

Precision Castparts Corporation has long been a leader in supplying complex metal components and

parts to the aerospace and other markets. However the aerospace market has matured with growth

slowing and some analysts even forecasting a flat or declining market. One growth area in the

aerospace market is occurring in drones, namely unmanned aircraft used in a wide range of applications

to include: defense, agriculture, firefighting, general commercial and personal / recreational uses.

Precision Castparts currently does not have any significant market share in the drone market. Precision

Castparts is considering launching a new set of products to be sold into the drone market. The drone

market was relatively nonexistent ten years ago, but has grown quite rapidly and is expected to do so

into the future. Precision Castparts has already invested $15 million in research, $5M in test marketing

and believes their products will be competitive with product offerings from other companies. You have

been approached by the president of the company to analyze the proposed project and make a

recommendation on whether Precision Castparts should launch the initial line drone products for the

commercial and defense sectors (Precision Castparts does not plan to introduce produces for drones

used in the personal / recreational sector).

In the current year 20,000 drones are expected to be sold worldwide and estimated to grow at rapid

rate of 45% per year. Of that total, 75% of the sales are currently classified as being used in commercial

and defense and the mix of commercial and defense is expected to decrease by 2.5 percentage points

each year in the future. Being a relatively new entrant to the market, Precision Castparts expects to

initially get a 5% share of the commercial and defense drone market and that market share will grow by

one percentage point per year. Once ready for sale, Precision Castparts’s first product line is expected

to be sold for 5 years, in the 6 th

year Precision Castparts plans to transition to a second generation of

drone products. In that 6 th

year half of the sales are expected to be comprised of the initial product line

and the other half comprised of the second generation. The set of products that Precision Castparts is

planning for the drone market could currently have a combined average selling price of $40,000 / drone

unit based on competitive offerings and the price is forecast to decrease by 4% per year. The company

is fairly confident in most of its projections, but market share and price are the two items with the most

variability.

The variable cost of goods sold is forecast to be $19,000 /drone unit at time of product launch and is

forecast to decrease by 5% / year as the company gains experience with the manufacturing process.

Selling and administrative expenses are expected to be 8% of sales each year.

Prior to launching the new product line, Precision Castparts will need to spend an additional $75 million

on R&D over the next two years to complete the design ($50M in the current year and $25M next year),

$10 million on test marketing and $100M on capital equipment to support the manufacturing process.

The equipment purchase and test marketing will be done one year prior to the start of sales. The

equipment will be depreciated using the seven year MACRS schedule. The equipment will have a $15

million salvage value after all sales of the initial product line have been completed and might be able to

be used in a future company project. Also, the company will need to invest $20 million in net working

capital prior to the first year of sales. Once sales begin the company will plan to maintain 55 days of

accounts receivable, 180 days of inventory and 60 days of accounts payable.

The corporate tax rate is 32%. To establish a discount rate, please use the Industry Approach (Pure Play)

to estimate the cost of equity. Please use The Boeing Company (BA) as the comparable company as the

majority of its business is in the commercial and defense segments of aerospace.

In your recommendation please include the payback period, NPV, IRR, MIRR and profitability index. Also

include an analysis to assess potential risk.

I am interested in the structured frameworks you use to solve the problem/s, assumptions made,

analysis, recommendation and ability to clear communicate. Grading will consider:

• Critical Thinking: Have you formulated meaningful questions (what are the critical issues or problem), synthesized information and financial data, considered alternatives or improvements,

proposed position / solutions.

• Analysis: Have you chosen the appropriate analytical framework/s to utilize and appropriately applied them. Assess quality of supporting evidence, key assumptions are identified and a clear

recommendation supported by the analysis.

• Communication: The paper must be written clearly with a central message and logical organization. Ideas and recommendations are well supported. The case should contain an

executive summary, framing of the problem, analysis, consideration of alternative solutions and

recommendation. Please ensure correct spelling, grammar and clear formatting of financial

exhibits. Use of tables and charts are often an efficient means to communicate financial

information.

Papers should be between 3-5 pages in length plus any exhibits in an appendix.

Absent Satisfactory Excellent

WACC 0 1 2 3 4 Comment

Overall framework and WACC

Cost of Equity (industry approach)

FCF Forecast

Overall framework

Proforma Income Statement

Proforma Balance Sheet

FCF Forecast

Decision Criteria

Decision Frmework

NPV, IRR, MIRR, PI

Risk Assessment

Communication

Overall Presentation

Executive Summary

Supporting evidence

Synthesis & Recommendation

Grammar, spelling

Use of Exhibits, Charts