Question

The sales and marketing team hired Smith and Smith Consulting to conduct a market survey. The total cost for this consulting was $32,500. Based on the survey and their own experience the sales and marketing has provided a sales forecast. The suggested price of the fire starter is $2.50 per starter and they would be sold as a four pack for $10.00. The unit sales forecast is 20,000 4-packs in year 1, 45,000 in year 2, 60,000 in year 3, 75,000 in year 4, and then increasing by 5,000 each year thereafter. Sales and marketing expenses are expected to be 10% of total revenue.

The production team forecasts that the fixed costs needed for the fire starter production line will be $90,000 per year. Variable costs for materials (cardboard, wood shavings, wax, packaging, etc.) will be $0.85 per unit or $3.40 per four pack. The labor and maintenance costs will vary based on what equipment will be purchased.

There are two brands of equipment that will do the job; The ABC brand and the XYZ brand.

The ABC brand is more expensive, but higher quality and more efficient. It will cost $525,000 plus an additional $30,000 for shipping and installation. The equipment would be depreciated to zero over 5 years using straight line depreciation. It is expected that the equipment would last for 8 years and would be sold then for $55,000. Maintenance of the ABC equipment would cost $5,000 per year but every 3 years the equipment would need an overhaul that would increase the cost to $75,000 for that year. Since the ABC equipment is more efficient the variable labor cost would be $0.60 per four pack.

The XYZ brand is less expensive. It will cost $395,000 plus an additional $40,000 for shipping and installation. The equipment would be depreciated to zero over 5 years using straight line depreciation. It is expected that the equipment would last for 8 years and would be sold then for $35,000. Maintenance of the ABC equipment would cost $10,000 per year but every 3 years the equipment would need an overhaul that would increase the cost to $85,000 for that year. The variable labor cost with the XYZ brand equipment would be $0.80 per four pack.

The increase in working capital (accounts receivable and inventory) is expected to be $60,000 at the beginning of the project and will be the same for both machines. The company’s cost of capital is 14% and its tax rate is 40%. Since her production team believes that both brands of equipment will last for eight years Michelle wants this analyzed as an eight year project.

Michelle has always believed in buying quality so she is leaning towards the ABC brand equipment. But after hearing that you have learned about capital budgeting in your Finance class at UVU she wants to take advantage of your expertise. Michelle has asked you to analyze her choices and give her some advice on which option would provide the best financial outcome for Green-Log Manufacturing.

Prepare an analysis and professional report for Michelle. The report should include attached schedules. The letter should explain what analytical techniques you are using, why you are using those techniques, what the results show, what you would recommend to Michelle and why. Also make sure that the letter includes the following:

1.         The cash flows associated with the different equipment brands for each year of the project.

2.         The PB period, Discounted PB, IRR, and NPV for the two alternatives.

3.         Your recommendation of which brand of equipment should be purchased.

**PLEASE INCLUDE YOUR RECOMMENDATION**

Answer 1

ABC Brand                  Year	0	1	2	3	4	5	6	7	8
Operating Cash flows
1.Units sales		20000	45000	60000	75000	80000	85000	90000	95000
2.Sales Revenue(Line 1*$ 10)		200000	450000	600000	750000	800000	850000	900000	950000
3. sales& mkg. Exp.(Ln.2*10%)		-20000	-45000	-60000	-75000	-80000	-85000	-90000	-95000
4. Fixed costs		-90000	-90000	-90000	-90000	-90000	-90000	-90000	-90000
5. Variable material costs(Ln.1*%3.40)		-68000	-153000	-204000	-255000	-272000	-289000	-306000	-323000
6. Variable labor cost(Ln.1*0.60)		-12000	-27000	-36000	-45000	-48000	-51000	-54000	-57000
7.Maintenance/Overhaul		-5000	-5000	-75000	-5000	-5000	-75000	-5000	-5000
8.Depreciation(555000/5)		-111000	-111000	-111000	-111000	-111000
9.EBT(Ln.2-sum3to8))		-106000	19000	24000	169000	194000	260000	355000	380000
10.Tax at 40%(Ln.9*40%)		42400	-7600	-9600	-67600	-77600	-104000	-142000	-152000
11. EAT(Ln.9+10)		-63600	11400	14400	101400	116400	156000	213000	228000
12. Add back: depn.(Ln.8)		111000	111000	111000	111000	111000	0	0	0
13.Cash from operations(Ln. 11+12)		47400	122400	125400	212400	227400	156000	213000	228000
14.NWC introd. & recovered	-60000								60000
15. Total annual opg. Cash flow(ln.13+14)	-60000	47400	122400	125400	212400	227400	156000	213000	288000
CAPEX costs
16.Costs+Shipping& Installation	-555000
17.After-tax salvage(55000*(1-40%))									33000
18. Total annual cash flows(15+16+17)	-615000	47400	122400	125400	212400	227400	156000	213000	321000
19.PV F at 14%(1/1.14^Yr.n)	1	0.87719	0.76947	0.67497	0.59208	0.51937	0.45559	0.39964	0.35056
20.PV at 14%(Ln.18*19)	-615000	41579	94183	84641	125758	118104	71072	85123	112529
21. NPV (Sum Ln. 20)	117989
Payback Period
Cumulative undiscounted cash flows	-615000	-567600	-445200	-319800	-107400	120000	276000	489000	810000
Payback Period=
(4+(107400/227400)=	4.47	Years
Cumulative discounted cash flows	-615000	-573421	-479238	-394597	-268839	-150735	-79663	5460	117989
Payback Period=
(6+(79663/85123))=	6.94	Years
IRR (of Ln.18)	18.35%

XYZ Brand
Year	0	1	2	3	4	5	6	7	8
Operating Cash flows
1.Units sales		20000	45000	60000	75000	80000	85000	90000	95000
2.Sales Revenue(Line 1*$ 10)		200000	450000	600000	750000	800000	850000	900000	950000
3.Sales& mkg. Exp.(Ln.2*10%)		-20000	-45000	-60000	-75000	-80000	-85000	-90000	-95000
4. Fixed costs		-90000	-90000	-90000	-90000	-90000	-90000	-90000	-90000
5. Variable material costs(Ln.1*%3.40)		-68000	-153000	-204000	-255000	-272000	-289000	-306000	-323000
6. Variable labor cost(Ln.1*0.80)		-16000	-36000	-48000	-60000	-64000	-68000	-72000	-76000
7.Maintenance/Overhaul		-10000	-10000	-85000	-10000	-10000	-85000	-10000	-10000
8.Depreciation(555000/5)		-87000	-87000	-87000	-87000	-87000
9.EBT(Ln.2-sum3to8))		-91000	29000	26000	173000	197000	233000	332000	356000
10.Tax at 40%(Ln.9*40%)		36400	-11600	-10400	-69200	-78800	-93200	-132800	-142400
11. EAT(Ln.9+10)		-54600	17400	15600	103800	118200	139800	199200	213600
12. Add back: depn.(Ln.8)		87000	87000	87000	87000	87000	0	0	0
13.Cash from operations(Ln. 11+12)		32400	104400	102600	190800	205200	139800	199200	213600
14.NWC introd. & recovered	-60000								60000
15. Total annual opg. Cash flow(ln.13+14)	-60000	32400	104400	102600	190800	205200	139800	199200	273600
CAPEX costs
16.Costs+Shipping& Installation	-435000
17.After-tax salvage(35000*(1-40%))									21000
18. Total annual cash flows(15+16+17)	-495000	32400	104400	102600	190800	205200	139800	199200	294600
19.PV F at 14%(1/1.14^Yr.n)	1	0.87719	0.76947	0.67497	0.59208	0.51937	0.45559	0.39964	0.35056
20.PV at 14%(Ln.18*19)	-495000	28421	80332	69252	112969	106574	63691	79608	103275
21. NPV (Sum Ln. 20)	149122
Payback Period
Cumulative undiscounted cash flows	-495000	-462600	-358200	-255600	-64800	140400	280200	479400	774000
Payback Period=
(4+(64800/205200))=	4.32	Years
Cumulative discounted cash flows	-495000	-466579	-386247	-316994	-204026	-97451	-33760	45848	149122
Payback Period=
(6+(33760/79608))=	6.42	Years
IRR (of Ln.18)	20.48%