Plywood Press Investment Evaluation: A Case Study of ABS

Emily Jones, a recent graduate with a Bachelor of Business Studies (BBS) degree, starts her new role at Albany Building Supplies (ABS), a timber firm based in Albany, north of Auckland. Despite her degree, Jones is hired because of her strong communication and people skills, and her sensitivity to real-world complexities. Her first assignment is to perform a financial evaluation of two new plywood presses, the Nakoi and the Dakota, and to critique the company's capital budgeting policies.

The plywood division is operating at capacity, and the purchase of an additional press is essential for expansion. While the Dakota press is more expensive, it offers advantages like higher production rate, lower labor costs, and better resale value. Jones' evaluation considers these factors, along with updated information provided by the General Manager, Thomas Wilson. Wilson's capital budgeting practices, termed 'FAPG' (Fixed Asset Purchase Guidelines), emphasize a conservative approach with a strong focus on forecasting accuracy. He utilizes payback period and average accounting rate of return (AARR) for relatively small investments, and also incorporates a target book return of 20 percent for larger projects. However, Wilson recognizes the importance of market returns and is open to considering projects with an expected return exceeding 15 percent.

Jones' evaluation, considering the revised information, includes an assumption of a 4 percent annual increase in selling price and cash costs, a 72 percent material cost to sales ratio, and a discount rate of 17 percent. The analysis involves calculating the net present value (NPV) for each press, considering factors like sales revenue, cash costs, depreciation, and taxes. The Dakota press emerges as the better investment option due to its higher NPV. This case study highlights the importance of a comprehensive approach to capital budgeting, incorporating various techniques and ensuring the accuracy of forecasts.