Plywood Press Investment Analysis: Evaluating Nakoi vs. Dakota for Albany Building Supplies

Emily Jones, a recent employee of Albany Building Supplies (ABS), is tasked with evaluating two new plywood presses, the Nakoi and the Dakota, for the company's plywood division. 'As I told you at our interview, I’m hiring you despite your BBS. I haven’t had good experiences with degree graduates. They tend to be too technical, lack communication skills, and view problems as mere academic exercises. But you seem to be different. Your recommendations cited your sensitivity to real-world complexities and I’ve been impressed with your communication and people skills, I think you can help us,' Thomas Wilson, ABS's General Manager, had said during her interview. Jones, a recent graduate from Massey University, is eager to 'make a difference' at ABS.

The plywood division is operating close to capacity, and Wilson is considering expanding production with a new press. The Nakoi, manufactured in Japan, costs $750,000, while the American-made Dakota costs $1,300,000, both figures including installation. The Dakota offers several advantages, including higher daily production, lower labor costs, and better resale value. However, the higher price raises the question of whether these benefits justify the extra cost.

Wilson has established a set of fixed asset purchase guidelines ('FAPG') for evaluating capital investments. For smaller investments (under $15,000), he relies primarily on the payback method, aiming for a payback period of 2-3 years. For larger projects, he utilizes both the payback method and the average accounting rate of return (AARR), aiming for an AARR exceeding the company's target book return of 20%. The project's payback should also be 'acceptable,' with no preference for a payback exceeding five years.

Wilson emphasizes the importance of accurate forecasting in capital budgeting decisions. He personally investigates forecasts that appear 'suspiciously low' and employs external consultants to compare actual cash flows with predictions. This dedication to forecasting accuracy is demonstrated by the company's post-audit results, which reveal a tendency for forecasts to be too conservative rather than overly optimistic.

Jones, however, recognizes the absence of discounted cash flow techniques in Wilson's capital budgeting process. While Wilson acknowledges that the 20% target return is a book rate, not a market rate, he is open to considering 'capital budgeting techniques based on market returns,' with a 15% market return being acceptable.

To evaluate the presses, Jones needs to consider revised information provided by Wilson:

1. The selling (market) price of plywood increases by 4% per year.

2. Cash costs also increase by 4% per year.

3. Material costs will run 72% of sales.

4. The appropriate discount rate is 17%.

5. Other estimates remain at their original values.

To make an informed recommendation, Jones will need to calculate the net present value (NPV) of each press using the updated information and the 17% discount rate. The NPV calculation will factor in the initial cost, annual cash inflows and outflows, and the salvage value for each machine over a seven-year time horizon.

The machine with the higher NPV will be the more financially feasible option for ABS. Jones will need to carefully analyze the results and consider both financial and operational factors to make a recommendation that aligns with the company's goals and resources.