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, but higher quality and moreefficient. It will cost $525,000 plus an additional $30,000 forshipping and installation. The equipment would be depreciated tozero over 5 years using straight line depreciation. It is expectedthat the equipment would last for 8 years and would be sold thenfor $55,000. Maintenance of the ABC equipment would cost $5,000 peryear but every 3 years the equipment would need an overhaul thatwould increase the cost to $75,000 for that year. Since the ABCequipment is more efficient the variable labor cost would be $0.60per 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 working capital (accounts receivable andinventory) is expected to be $60,000 at the beginning of theproject and will be the same for both machines. The company’s costof capital is 14% and its tax rate is 40%. Since her productionteam believes that both brands of equipment will last for eightyears Michelle wants this analyzed as an 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 include attached schedules. The letter should explainwhat analytical techniques you are using, why you are using thosetechniques, what the results show, what you would recommend toMichelle and why. Also make sure that the letter includes thefollowing:
1. The cashflows associated with the different equipment brands for each yearof the project.
2. The PB period,Discounted PB, IRR, and NPV for the two alternatives.
3. Yourrecommendation of which brand of equipment should be purchased.
**PLEASE INCLUDE YOURRECOMMENDATION**
