Financial Evaluation of Plywood Presses: A Case Study 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. Thomas Wilson, the firm's General Manager, provides her with revised information, including a 4% annual increase in selling price and cash costs, 72% material costs as a percentage of sales, and a 17% discount rate. Jones must re-evaluate the equipment with these changes.

The plywood division is a key component of ABS's business, operating near capacity. Wilson is considering an additional plywood press to expand production. He favors the Dakota due to its higher production rate, lower labor costs, and superior value retention. However, the Dakota is significantly more expensive. Exhibit 1 provides detailed information on each machine, including output, costs, and market value.

Wilson's capital budgeting practices, known as his 'Fixed Asset Purchase Guidelines' (FAPG), prioritize projects within the timber industry, utilizing payback and average accounting rate of return (AARR) as evaluation tools. He emphasizes the importance of forecasting accuracy, employing rigorous post-audits to ensure that forecasts are 'honest seekers of truth.'

Jones, recognizing the significance of her evaluation, must ensure her recommendations are not only accurate but also clearly justified. She must also consider the lack of discounted cash flow techniques in Wilson's current approach and the potential for incorporating market return-based capital budgeting techniques.

Here's a step-by-step analysis of the equipment with the revised information:

1. Annual Sales Revenue:

• Nakoi: 6,000 sq ft/day x 240 days/year x $1.80/sq ft = $2,073,600
• Dakota: 7,000 sq ft/day x 240 days/year x $1.80/sq ft = $2,419,200

2. Annual Material Costs:

• Nakoi: $2,073,600 x 0.72 = $1,493,952
• Dakota: $2,419,200 x 0.72 = $1,742,304

3. Annual Cash Costs (increasing by 4% per year):

• Nakoi: $276,000 + $52,000 + $78,000 = $406,000 (year 0)
• Dakota: $226,000 + $60,000 + $60,000 = $346,000 (year 0)

Year 1:

• Nakoi: $406,000 x 1.04 = $422,240
• Dakota: $346,000 x 1.04 = $359,840

Year 2:

• Nakoi: $422,240 x 1.04 = $438,777.60
• Dakota: $359,840 x 1.04 = $374,073.60

Year 3:

• Nakoi: $438,777.60 x 1.04 = $455,838.62
• Dakota: $374,073.60 x 1.04 = $388,933.98

Year 4:

• Nakoi: $455,838.62 x 1.04 = $473,441.47
• Dakota: $388,933.98 x 1.04 = $403,450.55

4. Annual Net Income:

• Nakoi:
  • Year 0: $2,073,600 - $1,493,952 - $406,000 = $173,648
  • Year 1: $2,155,977.60 - $1,493,952 - $422,240 = $240,785.60
  • Year 2: $2,240,616.66 - $1,493,952 - $438,777.60 = $308,886.06
  • Year 3: $2,327,587.25 - $1,493,952 - $455,838.62 = $377,796.61
  • Year 4: $2,416,953.34 - $1,493,952 - $473,441.47 = $446,559.87
• Dakota:
  • Year 0: $2,419,200 - $1,742,304 - $346,000 = $330,896
  • Year 1: $2,513,494.40 - $1,742,304 - $359,840 = $411,350.40
  • Year 2: $2,610,562.02 - $1,742,304 - $374,073.60 = $494,183.42
  • Year 3: $2,710,502.11 - $1,742,304 - $388,933.98 = $579,263.13
  • Year 4: $2,813,416.92 - $1,742,304 - $403,450.55 = $666,661.33

5. Average Book Value:

• Nakoi: ($750,000 - $75,000) / 7 = $96,429.71
• Dakota: ($1,300,000 - $390,000) / 7 = $130,000.00

6. Average Accounting Rate of Return (AARR):

• Nakoi:
  • ($173,648 + $240,785.60 + $308,886.06 + $377,796.61 + $446,559.87) / 5 / $96,429.71 = 0.916 or 91.6%
• Dakota:
  • ($330,896 + $411,350.40 + $494,183.42 + $579,263.13 + $666,661.33) / 5 / $130,000.00 = 1.253 or 125.3%

7. Present Value of Net Cash Flows (using a 17% discount rate):

• Nakoi:

  • Year 0: -$750,000

  • Year 1: $240,785.60 / 1.17 = $205,815.04

  • Year 2: $308,886.06 / 1.17^2 = $238,256.75

  • Year 3: $377,796.61 / 1.17^3 = $271,395.29

  • Year 4: $446,559.87 / 1.17^4 = $306,437.27

  • Year 5: $0.00 / 1.17^5 = $0.00

  • Year 6: $0.00 / 1.17^6 = $0.00

  • Year 7: $75,000 / 1.17^7 = $37,351.44

  • Total present value: -$750,000 + $205,815.04 + $238,256.75 + $271,395.29 + $306,437.27 + $37,351.44 = -$690,744.21

• Dakota:

  • Year 0: -$1,300,000

  • Year 1: $411,350.40 / 1.17 = $351,068.55

  • Year 2: $494,183.42 / 1.17^2 = $380,438.07

  • Year 3: $579,263.13 / 1.17^3 = $416,449.08

  • Year 4: $666,661.33 / 1.17^4 = $455,225.27

  • Year 5: $0.00 / 1.17^5 = $0.00

  • Year 6: $0.00 / 1.17^6 = $0.00

  • Year 7: $390,000 / 1.17^7 = $194,025.25

  • Total present value: -$1,300,000 + $351,068.55 + $380,438.07 + $416,449.08 + $455,225.27 + $194,025.25 = -$502,793.78

Conclusion:

The analysis suggests that the Nakoi press is not a viable option, with a negative net present value. The Dakota press, on the other hand, appears to be a viable option, with a positive net present value. However, it's crucial to remember that this analysis does not account for factors like company mission, payback period, and forecasting accuracy, which should be further considered in the decision-making process. Jones must also consider the implications of Wilson's current capital budgeting methods, which lack discounted cash flow techniques, and explore the potential of incorporating market return-based techniques.