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Stryker Corporation: Capital Budgeting case study looks into the corporation's systems and procedures for approving and authorizing capital spending of many different types. What should the corporation do to expedite the CER processes?
Timothy A. Luehrman
Harvard Business Review (208046-PDF-ENG)
August 31, 2007
Case questions answered:
- Briefly state the Business Case for Option#3. How would you compare this proposal to the other two options?
- Use the projections provided in the case to compute Incremental cash flows for the PCB procurement project and evaluate it financially?
- Clearly, articulate the categories of cash flows that you are modeling for your project?
- Is the Hurdle Rate appropriate for this project?
- Based on your analysis, would you recommend that Stryker fund this project?
- Identify the problem.
- Analyze and evaluate the situation.
- Based on your analysis, would you recommend that Stryker Corporation fund this project?
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Case answers for Stryker Corporation: Capital Budgeting
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Q1. Briefly state the Business Case for Option#3. How would you compare this proposal to the other two options?
Stryker Corporation – Overview
Stryker Corporation provides medical and surgical products. The divisions that are a part of this corporation include Orthopaedic implants, International sales, Rehabilitative Medical Services, and Medical and surgical equipment.
The Medical and Surgical equipment divisions’ revenue came from three business segments: Stryker Medical, Stryker Endoscopy, and Stryker Instruments. A critical electronic component needed for manufacturing many of the Stryker Instruments medical products was the Printed Circuit Board (PCB).
In 2012, this business segment generated $430 million global revenues, i.e., about 14% of the corporation’s total revenues for that year ($3 billion).
Option#3 PCB In-sourcing Proposal
For having an in-house production capability of PCB, a total capital expenditure of $6 million investment is required. But, possessing this capability to produce PCB in-house has several implications for our business.
We will be able to minimize the risk of getting bad quality PCB’s from suppliers. Also, our production of medical products will not be at the mercy of whether suppliers can fulfill my demand or not.
Similarly, we will able to minimize the inventory of PCB because, with in-house capability, we will only produce PCB that matches our demand for medical products. With this shift in production, we will have complete control over the product quality, delivery.
We can also map the value stream of the PCB production processes and eliminate any non-value-adding activity and increase the overall operational efficiency of the processes involved. We can now exercise complete control over the supply chain and optimize it according to our demand. This increase in efficiency will lower our costs and thus increase our profitability.
From Exhibit 1 (attached), we can see that we will need to invest heavily in specialized equipment to get our in-house PCB plant running, which means that we will be depreciating these assets and we know that depreciation is tax-deductible, thus increasing our bottom line.
Since we will be building this facility near our company headquarters, we can save on transportation and logistics costs. And there is a possibility that we may expand production capabilities and supply to our other Stryker Corporation business as well.
In short, with possessing an in-house production facility, I will be more confident in fulfilling my customer demand because of an increase in control oversupplying good quality PCB’s consistently. When we start producing PCB, then our working capital position will also improve as we will pay the supplier after 120 when we take that specific component from the stock for use.
Option#3 does require a huge capital investment, and it also requires us to increase human resources employed, payroll, and maintenance.
Option#1 does not require any capital expenditure, and it also mitigates some of the risk that is being currently faced by acquiring some safety stock and getting the supplies from dual sources.
But this option still poses a high risk of low-quality material, delivery, and responsiveness. Also, Stryker Corporation would have no control over maintain quality and timely delivery. Working capital will also be more constrained under this option as Stryker has to make quick payments to its suppliers.
Option#2 does increase the reliability of the supplier to provide quality material. Since this will be a sole partnership where the supplier will establish a separate facility (nearby to the manufacturing facility of Stryker), the timely delivery standard can be met reliably.
But, the downside is that Stryker would rely completely on this sole supplier for its continued operations. In the industry, the contract manufacturers operate on thin margins and face the continuous risk of bankruptcy. Thus, Stryker will be exposed to a high risk of operations disrupting if the supplier ran into a problem and is unable to supply materials to Stryker Corporation.
Q2. Use the projections provided in the case to compute Incremental cash flows for the PCB procurement project and evaluate it financially?
To gauge Option#3 for Stryker Corporation, we need to evaluate the incremental Cash Flows of the project, and thus we need to build a financial model. Then, we can evaluate it based on the NPV, IRR, and Payback criteria to base our conclusion. (Exhibit 4 for detailed financial model)
1. Initial Capital Expenditure
The capital expenditure on Site Preparation, construction, and site development is taken in 2013. Whereas, furnishing and non-manufacturing equipment, Communication & IT equipment, and Manufacturing Equipment would be allocated to…
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