Paccar Build vs Buy
Memorandum
To: John Harquest
From:
Date:
Re: Paccar’s Buy or Build Decision
Executive Summary
To maintain prominent competence in heavy truck manufacturing industry, PACCAR needs to upgrade major lines to the most efficient and advanced technologies. There are two options to be considered: purchasing technologies from outside providers or developing the technologies within the company. As financial analysts, we evaluate the two options by calculating and analyzing NPV, payback, IRR, and MIRR for each alternative. Analysis indicates that developing the technologies is more optimal as it outperforms the alternative in all measures. Among all measurements, we believe NPV to be the most effective. The details of our analysis are documented below.
NPV (Net Present Value) measures the expected change in wealth from undertaking the project. The NPV of purchasing is $60.34 million and $93.23 million for developing the technologies. NPV is the most effective measurement since both IRR and MIRR have the project scale issues. In this case, developing the technologies gives a greater NPV and is the best choice.
The Payback Period indicates that developing technologies in-house has a shorter payback period at 2.98 years, compared to purchasing at 3.33 years. Because both technologies require an investment recovery within the same 5 year useful life, both options are acceptable. We caution against using the payback period exclusively as it ignores cash flows after the payback period, the time value of the money received and any risk associated with the cash flows.
IRR (Internal Rate of Return) indicates the annual rate of return on an investment that assumes we could reinvest the cash flow at the same return. The IRR for purchasing and developing the product are 15.11% and 20.60% respectively. IRR tends to favor a larger scale project with larger cash flows in earlier time periods. It also suffers from in inaccurate reinvestment rate. We turn to MIRR to
To: John Harquest
From:
Date:
Re: Paccar’s Buy or Build Decision
Executive Summary
To maintain prominent competence in heavy truck manufacturing industry, PACCAR needs to upgrade major lines to the most efficient and advanced technologies. There are two options to be considered: purchasing technologies from outside providers or developing the technologies within the company. As financial analysts, we evaluate the two options by calculating and analyzing NPV, payback, IRR, and MIRR for each alternative. Analysis indicates that developing the technologies is more optimal as it outperforms the alternative in all measures. Among all measurements, we believe NPV to be the most effective. The details of our analysis are documented below.
NPV (Net Present Value) measures the expected change in wealth from undertaking the project. The NPV of purchasing is $60.34 million and $93.23 million for developing the technologies. NPV is the most effective measurement since both IRR and MIRR have the project scale issues. In this case, developing the technologies gives a greater NPV and is the best choice.
The Payback Period indicates that developing technologies in-house has a shorter payback period at 2.98 years, compared to purchasing at 3.33 years. Because both technologies require an investment recovery within the same 5 year useful life, both options are acceptable. We caution against using the payback period exclusively as it ignores cash flows after the payback period, the time value of the money received and any risk associated with the cash flows.
IRR (Internal Rate of Return) indicates the annual rate of return on an investment that assumes we could reinvest the cash flow at the same return. The IRR for purchasing and developing the product are 15.11% and 20.60% respectively. IRR tends to favor a larger scale project with larger cash flows in earlier time periods. It also suffers from in inaccurate reinvestment rate. We turn to MIRR to