Case Study: Corporate Modeling
1. The Case Description
Problem Background
Dixies is an established Australian company which currently imports all its products from overseas. Due to the recent changes in the Australian economy, it is thinking of manufacturing its products in Australia. It intends to manufacture shelving in the first instance. The company’s shelving comes in two types, a superior quality (Type A) and an inferior quality (Type B). The market for Type B is shrinking, and its selling price is depressed since there is a large amount of production capacity in several overseas plants for producing Type B only which are old and are desperate for markets. Dixies intends to produce both products at the plant. Some specific financial information is detailed in the following for facilitating the decision making process.
Capital Items
The proposed plant will produce both types of shelving: Type A and Type B. Capital investment will be an amount based on your student number.
- If your student number starts with a 3, the Capital Investment (initial investment
) is equal to the first 6 digits of your student number. (Thus if your student number is 3113008, the Capital Investment is $311,300).
- If your student number starts with 2, the Capital Investment is half your student number (Thus if your student number is 2001234P, the Capital Investment is $1,000,617).
- For any other numbers, the Capital Investment is equal to the first 6 digits of your student number.
The plant is expected to be viable for at least 10 years. However Dixies is assuming conservatively that the plant will have a life of Six (6) years. The Discount Rate used by the company for conducting the financial analysis is 12% per year.
Revenue Data
The demand for the shelving is assumed to be as follows:
|
Product |
Year 1 Demand (tons) |
Annual Growth |
Unit Selling Price ($ per ton) |
|
Type A |
5,400 |
+10% |
$1,315 |
|
Type B |
2,100 |
-15% |
$1,260 |
Capacity and Costs
Plant Capacity is 8,000 tons per year in total. The combined sales of Type A and Type B must not exceed this amount. If the capacity is tight, Type A shelving must have the priority. In other words, all the required Type A shelving should be produced and as much of the Type B shelving as the capacity constraint permits. Fixed Costs are $1,300,000 in the first year rising at 1% per year afterwards. Unit Variable Costs are $1,100 per tons for both Type A and Type B product.
Taxation
The depreciation rate for calculating the depreciation for tax purposes is 1/6 per year on a flat rate basis. The Tax Rate is 30%, due immediately. Dixies has substantial taxable profits from other parts of its business, so any ‘negative tax’ will be immediately taken up as profit.
Economic Factors
General inflation is assumed to be zero. Working Capital may be ignored. All money movements, other than initial capital outlay, are assumed to occur at the end of the year.
2. The Evaluation Tasks
a) Produce a spreadsheet model to obtain the Net Present Value of the net cash flow for the proposed plant.
b) Dixies investment group has estimated that if Dixies do not manufacture for the Type B market and produce a single purpose plant, producing only Type A product, the Initial Capital Investment is reduced by $30,000. Compare the Net Present Value of this proposal with the initial proposal assuming that Type A sales are the same in both cases.
c) What Initial Capital Investment would cause the proposal outlined in 2 to have the same Net Present Value as the initial proposal in 1?
d) Assuming that the Discount Rate is uniformly distributed between 10% and 14%, and that Type A growth rate is normally distributed with a mean of 10% and standard deviation of 1%, and Capital Investment is normally distributed with a mean of $960,000 and standard deviation of $25,000. Develop a pessimistic model and an optimistic model and further carry out a Monte Carlo analysis using 200 simulations.
e) Write a brief report that includes your recommendations together with your reasons for the problem described above to Dixies management.
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