Evaluating Plywood Presses: A Case Study in Capital Budgeting

Emily Jones, a recent graduate from Massey University, has landed a position at Albany Building Supplies (ABS), a timber company based in Albany, New Zealand. Despite her recent Bachelor of Business Studies (BBS) degree, Jones has impressed her General Manager, Thomas Wilson, with her communication and problem-solving skills. Her first assignment at ABS is to evaluate two new plywood presses, the Nakoi and the Dakota, which Wilson is considering purchasing to expand the company's production capacity.

Wilson outlines his capital budgeting practices, which he calls his 'fixed asset purchase guidelines' (FAPG). For smaller investments, ABS relies exclusively on the payback method, aiming for a payback period of 2-3 years. For larger investments, such as the new presses, the company also uses the average accounting rate of return (AARR). To be acceptable, a large investment must have a payback period less than 5 years and an AARR that exceeds the company's target book return of 20%.

Wilson places great emphasis on forecasting accuracy and monitors the company's forecasts closely. He believes forecasters must be 'honest seekers of truth' and is proud that a post-audit indicated a tendency for forecasts at ABS to be too conservative.

After her initial evaluation, Jones realizes that Wilson has revised the assumptions she used. He now expects a 4% annual increase in both the selling price of plywood and cash costs, with material costs representing 72% of sales. He also suggests a discount rate of 17% for the analysis.

Jones is tasked with reevaluating the presses using this revised information. The updated calculations show that the Dakota press is the preferred option with a higher present value, even with the revised assumptions.

The case study highlights the importance of a robust capital budgeting process that considers multiple factors, such as payback period, AARR, discounted cash flow analysis, and forecasting accuracy. It also emphasizes the role of communication and collaboration between management and employees in making informed investment decisions.