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Harding Plastic Molding Company On January 11, 2003, the finance committee of Harding Plastic Molding Company...
Harding Plastic Molding Company
On January 11, 2003, the finance committee of Harding Plastic Molding Company
(HPMC) met to consider eight capital budgeting projects. Present at the meeting were Robert L.
Harding, president and founder; Susan Jorgensen, comptroller; and Chris Woelk, head of
research and development. Over the past five years, this committee has met every month to
consider and make a final judgment on all proposed capital outlays brought up for review during
the period.
Harding Plastic Molding Company was founded in 1982 by Robert L. Harding to produce
plastic parts and molding for the Detroit automakers. For the first 10 years of operations, HPMC
has worked solely as a subcontractor for the automakers, but since then the company has made
strong efforts to diversify in order to avoid the cyclical problems faced by the auto industry. By
1998, this diversification attempt had led HPMC into the production of over 1,000 different
items, including kitchen utensils, camera housings, and photographic and recording equipment. It
had also led to an increase in sales 500 percent during the period 1992-2002. As this dramatic
increase in sales was paralleled by a corresponding increase in production volume, HPMC was
forced, in late 2001, to expand production facilities. This plant and equipment expansion
involved capital expenditures of approximately $10.5 million and resulted in an increase of
production capacity of about 40 percent. Because of this increased production capacity, HPMC
has made a concerted effort to attract new business and, consequently, has recently entered into
contracts with a large toy firm and a major discount department store chain. Still, non-autorelated
business represents only 32 percent of HPMC’s overall business. Thus, HPMC has
continued to solicit nonautomotive business, and as a result of this effort and its internal research
and development, the firm has four sets of mutually exclusive projects to consider at this month’s
finance committee meeting.
Over the past 10 years, HPMC’s capital budgeting approach has evolved into a somewhat
elaborate procedure in which new proposals are categorized into three areas: profit, research and
development, and safety. Projects falling into the profit or research and development area are
evaluated using present value technique, assuming a 10 percent discount rate; those falling into
the safety classification are evaluated in a more subjective framework. Bedsides the requirement
that research and development projects receive favorable results from the present value criteria, a
total dollar limit is assigned to projects of this category – typically about $750,000 per year. This
limitation was imposed by Harding primarily because of the limited availability of quality
researchers in the plastics industry. He felt that if more funds than this were allocated, “we
simply couldn’t find the manpower to administer them properly.” The benefits derived from
safety projects, on the other hand, are not measured in terms of cash flows; hence, present value
methods are not used in their evaluation. Evaluating safety projects is a pragmatically difficult
task requiring quantifying the benefits from these projects into dollar terms. Thus, safety projects
are subjectively evaluated by a management-worker committee with a limited budget. All eight
projects to be evaluated in January are classified as profit projects.
The first set of projects listed on the meeting’s agenda for examination involves the
utilization of HPMC’s precision equipment. Project A calls for the production of vacuum
containers for thermos bottles produced for a large discount hardware chain. The containers
would be manufactured in five different size and color combinations. This project would be
carried out over a three-year period. Project B involves the manufacture of inexpensive
photographic equipment for a national photography outlet. Although HPMC currently has excess
plant capacity, each of these projects would utilize precision equipment whose excess capacity is
limited. Thus, adopting either project would tie up all precision facilities. In addition, the
purchase of new equipment would be both prohibitively expensive and involve a time delay of
approximately two years, thus making projects A and B mutually exclusive. (The cash flows
associated with projects A and B are given in Exhibit 1.)
EXHIBIT 1
Harding Plastic Molding Company
Cash Flows
Year Project A Project B
0 $-75,000 $-75,000
1 10,000 43,000
2 30,000 43,000
3 100,000 43,000
EXHIBIT 2
Harding Plastic Molding Company
Cash Flows
Year Project C Project D
0 $-8,000 $-20,000
1 11,000 25,000
The second set of projects involves the renting of computer facilities over a one-year
period to aid in customer billing and perhaps inventory control. Project C entails the evaluation
of a customer billing system proposed by Advanced Computer Corporation. Under this system,
all the bookkeeping and billing presently being done by HPMC’s accounting department would
now be done by Advanced. In addition to saving bookkeeping costs, Advanced would provide a
more efficient billing system and do a credit analysis of delinquent customers, which could be
used in the future for in-depth credit analysis. Project D is proposed by International Computer
Corporation and includes a billing system similar to that offered by Advanced, as well as an
inventory control system that will keep track of all raw materials and parts in stock and reorder
when necessary, thereby reducing the likelihood of material stockouts, which has become more
and more frequent over the past there years. (The cash flows for projects C and D and given in
Exhibit 2.)
The third decision that faces the financial directors of HPMC involves a newly developed
and patented process for molding hard plastic. HPMC can either manufacture and market the
equipment necessary to mold such plastics or it can sell the patent rights to Polyplastics, Inc., the
world’s largest producer of plastics products. (The cash flows for projects E and F are shown in
Exhibit 3.) At present, the process has not been fully tested, and if HPMC is going to market it
itself, it will be necessary to complete this testing and begin production of plant facilities
immediately. On the other hand, the selling of these patent rights to Polyplastics would involve
only minor testing and refinements, which could be completed within the year. Thus, a decision
between the two courses of action is necessary immediately.
EXHIBIT 3
Harding Plastic Molding Company
Cash Flows
Year Project E Project F
0 $-30,000 $-271,500
1 210,000 100,000
2 100,000
3 100,000
4 100,000
5 100,000
6 100,000
7 100,000
8 100,000
9 100,000
10 100,000
The final set of projects up for consideration concerns the replacement of some of the
machinery. HPMC can go into one of two directions: project G suggests the purchase and
installation of moderately priced and extremely efficient equipment with an expected life of 5
years; while project H advocates the purchase of a similarly priced, although less efficient,
machine with a life expectancy of 10 years. (The cash flows for these alternatives are shown in
Exhibit 4.)
EXHIBIT 4
Harding Plastic Molding Company
Cash Flows
Year Project G Project H
0 $-500,000 $-500,000
1 225,000 150,000
2 225,000 150,000
3 225,000 150,000
4 225,000 150,000
5 225,000 150,000
6 150,000
7 150,000
8 150,000
9 150,000
10 150,000
As the meeting opened, debate immediately centered on the most appropriate method for
evaluating all projects. Harding suggested that since the projects to be considered were mutually
exclusive, perhaps their usual capital budgeting criterion of net present value was inappropriate.
He felt that, in examining these projects, they should be more concerned with some measure of
relative profitability. Both Jorgensen and Woelk agreed with Harding’s point of view, with
Jorgensen advocating a profitability index approach and Woelk preferring to use the internal rate
of return. Jorgensen argued that the use of profitability index would provide a benefit-cost ratio,
directly implying relative profitability, so that they would merely need to rank the projects and
select those with the highest profitability index. Woelk suggested that the calculation of an
internal rate of return would also give a measure of profitability and perhaps be somewhat easier
to interpret. To settle the issue, Harding suggested that they calculate all three measures, as they
would undoubtedly yield the same ranking.
From here the discussion turned to an appropriate approach to the problem of differing
lives among mutually exclusive projects E and F, and G and H. Woelk argued that there really
was no problem here, since all cash flows from these projects could be determined, any of the
discounted cash flow methods of capital budgeting would work well. Jorgensen argued that this
was true, but felt that some compensation should be made for the fact that the projects being
considered did not have equal lives.
What are the NPV, PI, and IRR for projects E and F? Are these projects comparable even though they have unequal lives? Critically evaluate. Which project should be chosen? Assume that these projects are not considered under a capital constraint.
Solutions
Expert Solution
Calculation of present value of future cashflow:-
Note : DCF stands for discounted cashflow. DCF = Cashflow*discount rate
| Calculation of IRR | ||||||||||
| Year | Cashflow Project A | Discount rate 27% | DCF - A @ 27% | Discount rate 28% | DCF - A @ 28% | Cashflow Project B | Discount rate 32% | DCF - B @ 32% | Discount rate 33% | DCF - B @ 33% |
| 1 | 10,000 | 0.7874 | 7,874 | 0.7813 | 7,813 | 43,000 | 0.7576 | 32,576 | 0.7519 | 32,331 |
| 2 | 30,000 | 0.6200 | 18,600 | 0.6104 | 18,311 | 43,000 | 0.5739 | 24,679 | 0.5653 | 24,309 |
| 3 | 100,000 | 0.4882 | 48,819 | 0.4768 | 47,684 | 43,000 | 0.4348 | 18,696 | 0.4251 | 18,277 |
| 75,293 | 73,807 | 75,950 | 74,917 |
IRR of Project A = Base rate + (DCF @ 27% - Initial outflow)*100/(DCF @ 27% - DCF @ 28%)
= 27% + (75293-75000)*100/(75293-73807) = 27% + 29300/1486 = 27%+0.2% = 27.2%
IRR of Project B = Base rate + (DCF @ 32% - Initial outflow)*100/(DCF @ 32% - DCF @ 33%)
= 32% + (75950-75000)*100/(75950-74917) = 32% + 95000/1033 = 32%+0.92% = 32.92%
IRR of Project C = (Cashflow at year 1 - Initial cash outflow)/Initial cash outflow
= (11000-8000)/8000 = 3000/8000 =32.5%
IRR of project D = (Cashflow at year 1 - Initial cash outflow)/Initial cash outflow
= (25000-20000)/20000 = 5000/20000 = 25%
IRR of project E = (Cashflow at year 1 - Initial cash outflow)/Initial cash outflow
= (210000-30000)/30000 = 180000/30000 = 60%
| Year | Cashflow Project F | Discount rate 35% | DCF - F @ 35% |
| 1 | 100,000 | 0.7407 | 74,074 |
| 2 | 100,000 | 0.5487 | 54,870 |
| 3 | 100,000 | 0.4064 | 40,644 |
| 4 | 100,000 | 0.3011 | 30,107 |
| 5 | 100,000 | 0.2230 | 22,301 |
| 6 | 100,000 | 0.1652 | 16,520 |
| 7 | 100,000 | 0.1224 | 12,237 |
| 8 | 100,000 | 0.0906 | 9,064 |
| 9 | 100,000 | 0.0671 | 6,714 |
| 10 | 100,000 | 0.0497 | 4,974 |
| IRR of Project F = 35% | 271,504 |
| Year | Cashflow Project G | Discount rate 34% | DCF - G @ 34% | Discount rate 35% | DCF - G @ 35% | Cashflow Project H | Discount rate 28% | DCF - H @ 28% | Discount rate 27% | DCF - H @ 27% |
| 1 | 225,000 | 0.7463 | 167,910 | 0.7407 | 166,667 | 150,000 | 0.7813 | 117,188 | 0.7874 | 118,110 |
| 2 | 225,000 | 0.5569 | 125,306 | 0.5487 | 123,457 | 150,000 | 0.6104 | 91,553 | 0.6200 | 93,000 |
| 3 | 225,000 | 0.4156 | 93,512 | 0.4064 | 91,449 | 150,000 | 0.4768 | 71,526 | 0.4882 | 73,228 |
| 4 | 225,000 | 0.3102 | 69,785 | 0.3011 | 67,740 | 150,000 | 0.3725 | 55,879 | 0.3844 | 57,660 |
| 5 | 225,000 | 0.2315 | 52,079 | 0.2230 | 50,178 | 150,000 | 0.2910 | 43,656 | 0.3027 | 45,402 |
| 6 | 150,000 | 0.2274 | 34,106 | 0.2383 | 35,749 | |||||
| 7 | 150,000 | 0.1776 | 26,645 | 0.1877 | 28,149 | |||||
| 8 | 150,000 | 0.1388 | 20,817 | 0.1478 | 22,165 | |||||
| 9 | 150,000 | 0.1084 | 16,263 | 0.1164 | 17,453 | |||||
| 10 | 150,000 | 0.0847 | 12,705 | 0.0916 | 13,742 | |||||
| 508,593 | 499,491 | 490,338 | 504,659 |
IRR of Project G = Base rate + (DCF @ 34% - Initial outflow)*100/(DCF @ 34% - DCF @ 35%)
= 34% + (508593-500000)*100/(508593-499491) = 34% + 859300/9101 = 34%+0.94% = 34.94%
IRR of Project H = Base rate + (DCF @ 27% - Initial outflow)*100/(DCF @ 27% - DCF @ 28%)
= 27% + (504659-500000)*100/(504659-490338) = 27% + 4659/15062 = 27%+0.33% = 27.33%
Compared data
| Sl.No | Particulars | Project A | Project B | Project C | Project D | Project E | Project F | Project G | Project H |
| 1 | Present value of future cashflow (above) | 109,016 | 106,935 | 10,000 | 22,727 | 190,909 | 614,457 | 852,927 | 921,685 |
| 2 |
 jeff jeffy answered 1 year agoRelated SolutionsHarding Plastic Molding Company On January 11, 2003, the finance committee of Harding Plastic Molding Company...Harding Plastic Molding Company
On January 11, 2003, the finance committee of Harding Plastic
Molding Company
(HPMC) met to consider eight capital budgeting projects. Present
at the meeting were Robert L.
Harding, president and founder; Susan Jorgensen, comptroller;
and Chris Woelk, head of
research and development. Over the past five years, this
committee has met every month to
consider and make a final judgment on all proposed capital
outlays brought up for review during
the period.
Harding Plastic Molding Company...
Harding Plastic Molding Company On January 11, 2003, the finance committee of Harding Plastic Molding Company...Harding Plastic Molding Company
On January 11, 2003, the finance committee of Harding Plastic
Molding Company
(HPMC) met to consider eight capital budgeting projects. Present
at the meeting were Robert L.
Harding, president and founder; Susan Jorgensen, comptroller;
and Chris Woelk, head of
research and development. Over the past five years, this
committee has met every month to
consider and make a final judgment on all proposed capital
outlays brought up for review during
the period.
Harding Plastic Molding Company...
Harding Plastic Molding Company On January 11, 2003, the finance committee of Harding Plastic Molding Company...Harding Plastic Molding Company
On January 11, 2003, the finance committee of Harding Plastic
Molding Company
(HPMC) met to consider eight capital budgeting projects. Present
at the meeting were Robert L.
Harding, president and founder; Susan Jorgensen, comptroller;
and Chris Woelk, head of
research and development. Over the past five years, this
committee has met every month to
consider and make a final judgment on all proposed capital
outlays brought up for review during
the period.
Harding Plastic Molding Company...
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