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You work at a Software as a Service (SaaS) company that has a suite of software programs to help businesses operate more efficiently. The market is rapidly evolving and many of the company’s clients are asking for a new solution that would be a natural addition to the company’s suite of SaaS products.
There is a startup that specializes in this product and they are already selling to in your target market. As a result, your organization has three options:
Build a technology product in-house
Collaborate with the startup
You are tasked with developing a recommendation for the CEO of your company. Your CEO believes that developing R&D capabilities is critical to the company’s future because of the rapid pace of change in technology and therefore, the short commercial life of products.
You explore how much it would cost to build a product with your own technology team. You work with the sales team to understand the revenue potential of your product. You develop the following projections:
It would cost $3M to build the solution in-house and it could be ready to launch into the market in one year.
The new solution would target your current user base, rather than attracting new users. Revenue from the new product is forecast to be $1.78M in Year 1, growing by $160K annually.
Ongoing operating costs (after the $3M investment) to service the solution and provide routine enhancements would be 40% of revenues.
The technology landscape is rapidly evolving so the software is expected to have a useful life of 5 years.
The CEO of the startup is willing to consider a joint venture and has proposed the following:
An upfront investment of $4M in year 0.
Your company incurs 50% of the operating costs, and retains 60% of the revenues.
Revenues are forecast be $3.42M in Year 1 and increase by $200K annually.
Ongoing operating costs (after the acquisition cost) to service the product and provide routine enhancements would be 50% of revenues.
If you do nothing, you estimate that you will lose some of your current customers. However, you believe you can stem the loss if you invest heavily in advertising. You develop the following projections:
You can make an upfront (year 0) investment of $12K in a 5 year advertising contract
The incremental revenue is forecast to be $125K in Year 1, declining by $62K annually.
The CFO of your company has told you to use 8% cost of capital for each scenario.
1. Calculate the following for each of the 3 options: (25 Points)
The Net Present Value (NPV) of the entire scenario
The five-year ROI on the original investment
The five-year Internal Rate of Return
2. What recommendation would you make to the CEO regarding the best option (Build vs. Joint Venture vs. Do-nothing-advertise)? Explain your rationale using NPV, 5-year ROI, and 5-year IRR as metrics. (25 Points)