Discussion and Analysis
The cost saving associated with implementing the new drying equipment is influenced by tax policy, fuel cost, economic outlook, and demand, each of which outlined below, followed by asummary recommendation. Appendix 1 contains the detail Net Present Value financial reviewand incorporates multiple factors including cash flows, tax credit and policy assessments, costsaving, salvage value and depreciation.
With the current legislation under consideration in congress three scenarios are considered likely:
Scenario 1: Legislation not enacted and status quo remains
Scenario 2: Legislation is enacted but existing purchases are grandfathered
Scenario 3: Legislation is enacted, Tax Credit is terminated and less favorable 7-year depreciation is mandated NPV analysis has been conducted for each scenario, based on a 12% cost of capital. Allcalculations are shown in detail in the appendix and summarized, in Figure 1, above. Figure 2calculates that expected saving obtained by multiplying the NPV from each scenario by theestimated probability of the occurrence, to arrive at an expected saving of $113,000, with bothfuel price and demand held constant based on current state..
Figure 2: Expected Savings (‘000s) based on predicted likelihood of tax scenarios
Scenario 1 $79 30% $24Scenario 2 $194 50% $97Scenario 3($38)20%($8)
Expected Savings $113
Fuel Costs and Inflation
Fuel costs are expected to contribute $360,000 of the estimated $560,000 annual cost savings. Awhopping 64% of the cost saving is based on fuel reduction so actual cost savings will be closelycorrelated to changes in fuel costs over the next decade. NPV calculations are based on theassumption that gas prices remain stable over the next decade. Over the last 10 years, gas priceson average rose 6.5% but much of this increase is attributed to the drastic rise in price in 1980and 1981, in the wake of the Iranian Revolution when global oil supply experienced disruption.Exclude these 2 years, and the average increase to gas prices falls to a modest 1.3, with the 3most recent years in decline (See Figure 3). Given the conflicting indicators on the future
BILL WATSON, CEO
TOBY ODENHEIM, PRINCIPAL CONSULTANT
SCIENCE TECHNOLOGY COMPANY STRATEGIC SUMMARY
MARCH 20, 1985
Although industry growth for automated test equipment (ATE) and very-large-scale integration(VLSI) increased dramatically from 1978 to 1984, this growth is being outpaced by new entrantsand competitors. Global competition, which in many countries is propped up by governmental policy and price supports, is resulting in excess supply and rapidly falling prices. Thusobsolescence is a risk for many industry players, Scientific Technology Company (STC)notwithstanding. Equally concerning, when compared to key competitors, STC is lagging behindon a number of financial metrics including earnings growth, return on equity, and return onassets.To remain viable STC should adopt a two-fold strategy, focused on cost-savings and innovation,in order to maintain leadership in ATE and testing software, and strengthen their patents andintellectual property portfolio.
STC must implement immediate cost-cutting measures to improve financial position and remaincompetitive in the face of increasing competition in both the U.S. and abroad. Specific cost-saving measures include:
Narrow core focus and concentrate on automated test equipment and software.
Havinga broad array of diverse product lines distracts the business from being best-of-breed in themost profitable sectors.
Sell off VLSI division and other secondary product lines that can command a good price.
Capture revenue from profitable but non-essential lines without further investment,harvesting as much profit prior to obsolescence.
Close Colorado plant and sell associated fixed assets
. While it makes sense to maintain both an east coast and west coast presence for manufacturing, sales and support, two separatefacilities in adjacent states results in added expense and excess manufacturing capacity.Outsource manufacturing if additional capacity is required.
Close unprofitable sales and service offices
. Rather than maintaining offices in over adozen international locations, close unprofitable offices and work through resellers andstrategic partnerships to support dispersed geographic locations in secondary markets.