You work for the investment management department of Western Muskegon Machining and Manufacturing (WM3), a highly successful machining and manufacturing company with many facilities in US.
Your group has a budget of $1,000,000 and needs to decide which project(s) to invest among four mutually exclusive options, which are described below.
Option 1
The production manager and manufacturing engineer in the assembly department of WM3's facility in Tennessee have designed a new assembly fixture. The fixture will reduce the assembly time of a product from 38 minutes to 20 minutes per unit, saving $16.84 per unit in direct labor. The fixture will cost $200,000 to fabricate and can be ready by December 31, 2017 (assume the fixture is paid only when it is ready). The fixture will have a six year useful life if properly maintained. Its salvage value will be negligible, as its general usefulness is limited.
In figuring the cost savings, the production manager points out that $88 of overhead is charged for each hour of direct labor. The manufacturing engineer points out that in this overhead charge are the fringe benefits and other payroll-related costs of 38.5%, which are incurred for each hour of direct labor, and that these costs are expected to increase by 1.5% per year. The other 61.5% of overhead charges account for other overhead expenses, which are expected to increase by 4.5% per year.
The new operation will require an additional 100 ft2 of floor space. The space is available in an adjacent department, which recently reduced its requirements when it did a similar project. The assembly department will pay $15 annually per ft2 in the first year (2018). This cost is expected to increase at a general inflation rate of 2.5% per year for the next five years.
The product will have a demand of 2,500 units the first year (2018). There is some uncertainty on the demand over the next five years. Marketing believes that there is a 35% chance that demand will increase by 500 units per year until 2023. There is a 45% chance that demand will remain constant at 2,500 units until 2023. There is also a 20% chance that demand will be 1,500 units for the next two years and 1,000 for the next three years.
Option 2
The manager of the Tool & Die department of WM3's facility in South Carolina wants to replace an existing CNC machine with a new one by the end this year (2017). The new machine has a useful life of 10 years and costs $400,000 plus installation costs of $15,000. It will generate annual revenues of $230,000 and annual expenses of $100,000. This new machine is depreciated over a seven years MACRS property class and has no salvage value.
Current machine has a book value of $90,000, remaining depreciable life of five years with no salvage value, and it is depreciated through the straight line depreciation method. Current machine can be sold by December 31, 2017 for $55,000. If retained, current machine will be overhauled with a cost of $180,000 at the end of year five to extend its useful life for five more years. Current machine will generate annual revenues of $150,000 and annual expenses of $120,000.
Option 3
Currently, WM3's facility in Delaware rents out a warehouse by $255,000 per year to store all its raw and finished products. Instead, WM3 can build its own warehouse for a cost of $700,000. Consequently, the company will be able to save the cost with renting every year. You can assume that the warehouse will be ready for use by December 31, 2017 and the initial cost will be paid in full by this date.
However, there are rumors that this facility will close in the future. There is a 20% chance that will close in four years (by the end of 2021), 35% chance that will close in seven years (by the end of 2024), and 45% chance that will close in 10 years (by the end of 2027). Assume that the renting cost amount increases at a general inflation rate of 2.5% per year.
Option 4
WM3 is planning to add an additional product to its portfolio. Costs with R&D and retooling of production are estimated to be $300,000, paid by December 31, 2017. The product can be launched until the end of 2017 but production will start only next year. Useful life of this product is estimated to be uniformly distributed over 5, 6 and 7 years.
There is a 20% chance that yearly demand of this product will be normally distributed with a mean of 8,000 and standard deviation of 600, 60% chance that yearly demand will be normally distributed with a mean of 12,000 and standard deviation of 1,200, and 20% chance that yearly demand will be normally distributed with a mean of 18,000 and standard deviation of 2,000. The manufacturing engineering department estimated annual fixed expenses and variable cost to be $75,000 and $36, respectively.
Moreover, the marketing department estimated unit price to be $51. WM3 agreed to produce this new product at its facility in San Luis, AZ, which currently has the highest unemployment rate among all US cities. Because of that, the US government will not tax any profit made with this product.
General Requirements
Perform an after-tax analysis for each option (excluding Option 4). Let MARR be 15% and tax rate be 34%. Use EUAW to compare each option.