In 1997 Michelle Green started Green-Log Manufacturing, acompany dedicated to manufacturing environmental friendly man madelogs that can be burned in fire places, fire pits in the backyard,and when camping. The logs are made from environmental friendlyproducts like cardboard and clean wax and emit fewer greenhousegases and less harsh chemicals. The logs come in three pound andfive pound sizes. Green-logs are also available with citronella toward off mosquitos. The Green-Logs have been well received. Revenueand profits have grown steadily.
Based on the recommendation from her sales and marketingdepartment Ms. Green is considering adding a new product line ofGreen-Log fire starters. These fire starters would be ideal for theoutdoor market of camping, fishing, backpacking, and tailgating.Ms. Green has asked her sales and marketing team to come up with asales forecast for units and pricing. She has also asked hermanufacturing team to come up with alternatives for the productionof the fire starters including what equipment is needed and whatthe projected costs would be.
The sales and marketing team hired Smith and Smith Consulting toconduct a market survey. The total cost for this consulting was$32,500. Based on the survey and their own experience the sales andmarketing has provided a sales forecast. The suggested price of thefire starter is $2.50 per starter and they would be sold as a fourpack for $10.00. The unit sales forecast is 20,000 4-packs in year1, 45,000 in year 2, 60,000 in year 3, 75,000 in year 4, and thenincreasing by 5,000 each year thereafter. Sales and marketingexpenses are expected to be 10% of total revenue.
The production team forecasts that the fixed costs needed forthe fire starter production line will be $90,000 per year. Variablecosts for materials (cardboard, wood shavings, wax, packaging,etc.) will be $0.85 per unit or $3.40 per four pack. The labor andmaintenance costs will vary based on what equipment will bepurchased.
There are two brands of equipment that will do the job; The ABCbrand and the XYZ brand. The ABC brand is more expensive, buthigher quality and more efficient. It will cost $525,000 plus anadditional $30,000 for shipping and installation. The equipmentwould be depreciated to zero over 5 years using straight linedepreciation. It is expected that the equipment would last for 8years and would be sold then for $55,000. Maintenance of the ABCequipment would cost $5,000 per year but every 3 years theequipment would need an overhaul that would increase the cost to$75,000 for that year. Since the ABC equipment is more efficientthe variable labor cost would be $0.60 per four pack.
The XYZ brand is less expensive. It will cost $395,000 plus anadditional $40,000 for shipping and installation. The equipmentwould be depreciated to zero over 5 years using straight linedepreciation. It is expected that the equipment would last for 8years and would be sold then for $35,000. Maintenance of the ABCequipment would cost $10,000 per year but every 3 years theequipment would need an overhaul that would increase the cost to$85,000 for that year. The variable labor cost with the XYZ brandequipment would be $0.80 per four pack. The increase in workingcapital (accounts receivable and inventory) is expected to be$60,000 at the beginning of the project and will be the same forboth machines. The company’s cost of capital is 14% and its taxrate is 40%. Since her production team believes that both brands ofequipment will last for eight years Michelle wants this analyzed asan eight year project.
Michelle has always believed in buying quality so she is leaningtowards the ABC brand equipment. But after hearing that you havelearned about capital budgeting in your Finance class at UVU shewants to take advantage of your expertise. Michelle has asked youto analyze her choices and give her some advice on which optionwould provide the best financial outcome for Green-LogManufacturing.
Prepare an analysis and professional report for Michelle. Thereport should be professionally written and include a two pageletter, plus attached schedules. The letter should explain whatanalytical techniques you are using, why you are using thosetechniques, what the results show, what you would recommend toMichelle and why. Make sure that the letter is well organized andprofessionally written. Also make sure that the letter includes thefollowing:
1. The cash flows associated with the different equipment brandsfor each year of the project.
2. The PB period, Discounted PB, IRR, and NPV for the twoalternatives.
3. Your recommendation of which brand of equipment should bepurchased.
4. Attach to your letter schedules that show your analysis andyour work. Please submit files. A Word file with your letter and anExcel file with your analysis.
