Stryker Corporation: Capital Budgeting – Case Solution

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Stryker Corporation: Capital Budgeting Case Answers

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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 in global revenues, i.e., about 14% of the corporation’s total revenues for that year ($3 billion).

Q1. Briefly state the Business Case for Option#3. How would you compare this proposal to the other two options?

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 PCBs 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 be able to minimize the inventory of PCBs because, with in-house capability, we will only produce PCBs that match our demand for medical products. With this shift in production, we will have complete control over product quality and delivery.

We can also map the value stream of the PCB production processes, 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, by possessing an in-house production facility, I will be more confident in fulfilling my customer demand because of an increase in control of oversupplying good quality PCBs consistently. When we start producing PCB, 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.

Comparison

Option#1 does not require any capital expenditure, and it also mitigates some of the risks that are currently faced by acquiring some safety stock and getting supplies from dual sources.

However, this option still poses a high risk of low-quality material, delivery, and responsiveness. Also, Stryker Corporation would have no control over maintaining 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 (near 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, contract manufacturers operate on thin margins and face the continuous risk of bankruptcy. Thus, Stryker will be exposed to a high risk of operations disruption if the supplier runs 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 was taken in 2013. Whereas furnishing and non-manufacturing equipment, Communication & IT equipment, and Manufacturing Equipment would be allocated to…