Find the cash flow of those 3 scenarios and recommendations for the 3 decisions.
NEW HAMPSHIRE RACING, INC.
The Situation
In June of 2000, Bryan D'Ander was hired by New Hampshire Racing, Inc. (NHR), and assigned to work in the finance department. NHR, located in New Hampshire and founded in 1990, is a producer of racing collectibles and memorabilia, specializing in personalizing clothing accessories such as hats, shirts, and jackets. Racing has always been a popular sport, but, over the last decade, racing had become one of the largest nationwide spectator sports. In New Hampshire, the mid-size Loudon speedway, which was on the NASCAR circuit, held two major racing events each year. Each race was drawing well over 100,000 high-spirited fans, and there was a growing demand for racing items sold at the tracks on race day. NHR's success had risen along With the sport's popularity and the good economic times of the last 10 years.
Bryan had recently graduated from a large university in the Northeast with a B.S. in Finance and Economics. During his senior year in college, Bryan had taken, as required by his major, a corporate finance course where he learned about capital budgeting and assessing and valuing projects. In addition, Bryan had been a Learning Center tutor, working with other students who needed help with their Accounting and Finance courses. So Bryan was one of the fortunate ones. Not only did he get a job soon after graduating, but he also was assigned to a department where he could use his education and training.
NHR's Chief Financial Officer, Ms. Miles, was aware of Bryan's background, and thought a good first assignment for him would be to examine six recently proposed projects-three pairs of mutually exclusive projects, to be exact The NHR staff barely had started the analyses on these projects, so it would not be difficult for Bryan to come up to speed. That said, however, a decision on these projects would have to be made soon. NHR's CEO, Mr. LaBlanc, was scheduled to meet with Ms. Miles later in the week. Bryan did not have much time.
Bryan gathered up the data collected so far on these projects, headed back to his desk, and started in. He wanted to make a good impression, so he was determined to have a proper valuation completed and recommendation written before his boss' meeting with Mr. LaBlanc.
A. New T-Shirt Orders
The first set of projects consisted of two new t-shirt orders that NHR recently had received. Since NIIR's screen printing production facilities were operating close to full capacity and the customers needed their first deliveries quickly, only one of the projects could be accepted. There just was not time to order and install new machinery to meet the combined demand of the new orders.
The first order was from Illinois Speedway. This speedway had been around for 25 years, and was one of NHR's loyal and regular customers. Since the speedway was built so long ago, it did not have all the amenities of the newer, more modern racing tracks. Consequently, a new racing track was to be built, and was slated to open in about four years. Once the new race track was up and running, the current speedway would be closed down. The owners of the Illinois Speedway wanted to have t-shirts commemorating the historic speedway to sell at races over the next four years. Projected sales of the commemorative t-shirts were expected to decline over the four years leading up to the opening of the new race track.
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Table 1 - Projected Sales to Illinois Speedway
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Year
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0
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1
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2
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3
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4
|
|
|
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$1,000,000
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$850,000
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$500,000
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$275,000
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The second order was from North Carolina based Smith Racing. The race car team recently had added a new driver, John Jones, who was catching on very quickly. The Smith Racing order called for delivery of t-shirts over the next four years, as that is how long Jones had signed on to race for Smith Racing. Given the growing demand for "JJ" t-shirts, the projected sales were expected to increase dramatically over the next four years.
What's more, many people were projecting that Jones would be the next major star in auto racing. There already had been talk in racing circles that Jones was going to sign on for another 4 years, and that his contract renewal was almost certain. If this happened, there was also a potential for future, major "JP collectibles and memorabilia orders.
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Table 2 - Projected Sales to Smith Racing
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Year
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0
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1
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2
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3
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4
|
|
|
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$275,000
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$400,000
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$925,000
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$1,500,000
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The two orders had the same costs.
a. Cost of goods sold would be 70% of sales.
b. Administrative costs would be 10% of sales.
c. Start up costs would be $25,000, and would be expensed immediately.
d. New folding/packaging machine would cost $150,000, and have a salvage value of $10,000 at end of 4 years.
e. The MACRS 3-year depreciation schedule would be used.
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Modified Accelerated Cost Recovery System (MACRS)
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Year 1
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33%
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Year 2
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45%
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Year 3
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15%
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Year 4
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7%
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Total
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100%
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f. NHR's effective tax rate was 27%.
g. Appropriate discount rate would be 10%.
B. Additional Screen Printing Machine
The second set of projects involved the purchase of a new t-shirt screen printing machine. NHR had been receiving a large number of new orders, yet the company had to turn down the majority of the orders. As evidenced by the Illinois Speedway and Smith Racing orders, NHR just did not have enough production capacity to meet demand.
There was no doubt that NI-IR needed an additional screen printing machine. The question was what size machine to purchase. A smaller machine would have a lower initial cost, and would allow MR to accept the majority of the new orders it had been receiving. On the other hand, a larger machine would cost substantially more, true, but a larger machine would not only allow NHR to accept all the orders it had been turning down, but also would allow for a substantial increase in production. Given auto racing was more popular than ever before, as well as the potential future orders for "ll" t-shirts, NHR just might need the additional production capacity. Moreover, Mr. LaBlanc had been hinting that he would like to expand beyond auto racing and into additional sport markets.
The smaller printing machine would cost $600,000 to purchase, deliver, and install. This machine would produce sales of $1,150,000 a year, and would have an 8 year life and an estimated $20,000 salvage value,
The larger printing machine would cost $1,000,000 to purchase, deliver, and install. This machine would produce sales of $1,750,000 a year, and would have an 8 year life and an estimated $45,000 salvage value.
An additional issue here, for both the smaller and the larger new screen printing machines, is that some of the sales attributed to the new machines actually would come from orders that could be completed using NFIR's existing machine. These "duplicated" sales were estimated to be $100,000 per year for the remaining four year lives of NFIR's existing printing machine. The cost of goods sold for these duplicated sales would be the same for all machines-old and new, small and large.
The two printing machines had the same following costs,
a. Cost of goods sold would be 70% of sales.
b. Administrative costs would be 10% of net sales.
c. The MACRS 5-year depreciation schedule would be used.
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Modified Accelerated Cost Recovery System (MACRS)
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Year 1
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20%
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Year 2
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32%
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Year 3
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19%
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Year 4
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12%
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Year 5
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11%
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Year 6
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6%
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Total
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100%
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d. NHR's effective tax rate was 27%.
e. Appropriate discount rate would be 14%.
C. Replacement Embroidery Machine
The last set of projects Bryan was to examine consisted of two alternatives for replacing an existing, and old, embroidery machine. The existing machine was not only old, but was also outdated when compared to the newer machines now on the market. Embroidery machine technology had certainly advanced in the last few years. The old machine, not surprisingly, was fully depreciated, but still had an estimated $2,000 salvage value. NHR was considering one of two new machines to replace the existing one.
The first embroidery machine under consideration would cost $130,000 to purchase, deliver, and install, and would have a 5 year life and an estimated $2,500 salvage value.
The embroidery second machine would cost $200,000 to purchase, deliver, and install, and would have a 10 year life and an estimated $4,000 salvage value.
The two machines under consideration had the same following savings and costs.
a. Savings would be $50,000 per year.
b. The MACRS 5-year depreciation schedule again would be used.
c. NHR's effective tax rate was 27%.
d. Appropriate discount rate would be 14%.