dividually students will develop a formal response to the
problem(s) posed in the case, addressing the following areas within
the analysis, and using the same headings. (Numbers in brackets do
not necessarily correspond to length but represent the weight that
will be given to each section in the grading):
- Issue Identification (5%): Identification of
the problem/issue that must be resolved or decision that must be
made. Phrase the problem/cause in the most succinct way possible.
Think about:
- Differentiating the immediate from the basic problem
- The implications of the problem(s)
- Identifying the root cause of the problem(s)
- Determining the decision facing the key person(s)?
- Identification of Key Success Factors (10%):
Identify the company-specific factors in point form that are
absolutely critical to the success of the organization. These are
the factors that, if ignored, will mean the project will probably
fail. Include the following considerations:
- What factors must be managed successfully for the company to
prosper?
- Key success factors should reflect the top priorities of the
organization in this particular case (eg., quality, productivity,
low cost leader, etc.)
- These factors are part of the criteria against which you will
evaluate solutions (along with basic criteria such as profit)
- Identification of Alternatives (5%): Identify
alternative solutions. Only deal with feasible alternatives. In the
next three sections, analyse all alternatives against criteria set
out in key success factors and basic requirements (eg.,
profitability).
- Quantitative Analysis (40%): Push numbers in
an analysis that is relevant to the issue at hand. Differentiate
between what is relevant and what is irrelevant.
- Qualitative Analysis (30%): Be sure to analyze
qualitative issues – they need discussion in most cases. In
particular, analyze alternatives in light of key success factors –
will this alternative solve the problem and fit with our key
success factors.
- Recommendation on Course of Action (5%): State
your recommendation. State briefly the justification for your
recommended course of action. Make sure your recommendation flows
out of your quantitative and qualitative analyses. Tie your
recommendation back to the key success factors. The solution and
implementation shout fit with problems and criteria identified
above.
- Circumvention of Potential Problems (5%): If
there could be problems with your recommendations, state them. As
well, suggest ways to overcome these problems – a contingency plan
to address potential difficulties.
There is no set length to the report, but clear, succinct and
concise language and organization will be considered favourably in
the grade.
Students will submit the final report as a word document through
the submission link below.
The Case
You are a Senior Consultant for the professional service firm,
BUSI 2083 LLP. Your firm specializes in providing a wide variety of
internal business solutions for different clients. It is your final
week on the job and a Manager asks you for some help prior to your
departure. Eager to leaving a lasting impression, you start reading
the background information provided by the Manager.
Lesley Donovan is the controller for the East division of
Explorer Ltd. Jason Conner, head of plant engineering, has just
left Donovan’s office after presenting three alternatives for
submission in the capital expenditure budget for the fiscal year
2014. The budget is due to the CEO in two days and therefore
Donovan realizes that time is of the essence.
Conner has outlined the following alternatives to replace an
outdated milling machine:
- build a general purpose milling machine;
- buy a special purpose numerically controlled milling machine;
or
- buy a general purpose milling machine.
Explorer Ltd. is a well-established company. The company was set
up about 30 years ago by two brothers Dan and Kevin Thompson, in
Huntsville, Ontario, to produce accessories for the automobile
industry. The Central division continues to serve the auto
industry, and is the largest division in the company with sales of
$35 million annually. Dan’s son is now head of this division. Kevin
is still active in the company and is the Chief Executive Officer
(CEO). His office is located in Toronto.
The parts division supplies seals to the mining and
petrochemical industry from a plant in Toronto. This division is
only ten years old and until 2010 was highly profitable. As a
result of the downturn in the sector of the economy, sales in 2012
were only $12 million.
The East division, located in Scarborough, is the engineering
division. Full-time employees tend to work approximately 2,000
hours in the division. Regular product lines include industrial
fans, industrial cooling units, and refrigeration units for
industrial users. The division is highly capital-intensive and
sales tend to be directly related to general economic
conditions.
Each division runs independently and performance is based upon
budgeted return on investment. Bonuses are paid if the budget
target is achieved. Annually, each division prepares a detailed
budget submission to Kevin, outlining expected profit performance
and capital expenditure requests. The milling machine proposal is
part of the capital expenditure request.
The 2013 pro forma income statement for East division is set out
below:
Sales
|
$22,364,000
|
Cost of Goods Sold
|
$14,760,240
|
Gross Profit
|
$7,603,760
|
Selling and General Administrative Costs
|
$3,578,760
|
Allocated Costs (based on sales)
|
$1,677,300
|
|
|
Income Before Income Taxes
|
$2,347,700
|
Return on Sales – 10.5%
|
|
Return on Investment – 8.5%
|
|
Investment (Historical Cost)
|
$27,626,118
|
Jason Connor has pointed out to Donovan that the existing
machine is not only outdated but maintenance costs are becoming
prohibitive. Jason also noted that maintenance costs of new general
purpose machines are only $26,000 while special purpose machines
can save an additional $14,000 in maintenance. Also there would be
a significant savings in insurance as the price for a general
purpose machine would drop to $3,000 while a special purpose
machine would be 67% higher than the general purpose machine. The
machine has no market or salvage value and he is sure that its book
value is now zero. The trouble is that he doesn’t know which
proposal is best for the company. In addition to the cost and
revenue date provided, Connor provided comments on each alternative
below:
- Build a general purpose machine:
- This machine can be built by East division. The division is
below capacity at present as a major contract has just been
completed. The division could thus produce the machine without
affecting revenue-producing activity, but it will take six months
to complete. The machine is expected to last five years and have no
salvage value because removal costs will probably equal selling
price.
- Connor believes that the division has the technical expertise
to undertake the work. In 2012, the division produced a specialized
drilling machine that has proven very successful. Connor pointed
out that David Williams, chief engineer, loves the design challenge
of new machines. Donovan sat down with Connor and produced the
following cost estimates:
Material and parts
|
$55,000
|
Direct labour (DL$)
|
$90,000
|
Variable overhead (50% of DL$)
|
$45,000
|
Fixed overhead (25% of DL$)
|
$22,500
|
TOTAL
|
$212,500
|
- Donovan argues that this job should also bear a proportion of
administrative costs; she suggests $12,000.
- Buy a special purpose machine:
The advantage of this special purpose machine is that only one
operator is required and output per hour could increase by 25%. In
addition, maintenance costs are significantly reduced because
microchip circuitry is employed.
Connor points out that this machine is state-of-the-art and would
probably mean that new work could be taken on. A numerically
controlled machine required extensive training of operators. In
total, 26 weeks are spent in the supplier’s factory located in
Florida. While the training is going on, the supplier provides an
operator to work the machine without charge. Expected costs of this
training period including hotel, per diem, and travel will cost
$3,000 per week, excluding the operator’s labour which is set at
$15 per hour.
The machine costs $625,000, and the supplier guarantees the salvage
value of $25,000 at the end of five years. It is available
immediately. It is estimated the machine can generate sales of
$243,750 annually at full capacity and require $19,500 in direct
materials cost. While the direct material costs are equivalent, the
level of sales for the general purpose machine are $48,000 lower
than the special purpose machine.
- Buy a general purpose machine:
The purchase price of this machine is $295,000 and cost levels
associated with the machine are expected to be the same as the
general purpose machine built by the company because the technology
is similar. The salvage value of the machine net of removal costs,
is estimated to be $5,000 in five years. It can be delivered
immediately.
General comments
The required rate of return for this investment class has been
set at 8% by Kevin Thompson.
Required
Prepare the budget submission to Kevin. Show your answers.