In November 2006 Charles Bird, President of Bird Packaging Co. in Guelph, Ontario, was trying to decide whether the company should purchase a new scoringprinting machine. The attraction of the new machine was that it would double capacity and also reduce labour costs. However, the relatively large capital outlay and the uncertainty of projected sales concerned Bird, so he was anxious for a thorough and careful analysis of future cash flows. 

Bird Packaging is a small firm, which caters to the packaging needs of small and medium-sized firms within an 80-kilometre radius of Guelph, including the cities of Hamilton, Kitchener-Waterloo, and Mississauga. Bird Packaging was established about 10 years ago with first-year sales of $120,000. Sales in 2006 were projected to reach $1,900,000. The present workforce comprises 24 employees. Its operations include cutting, folding, and printing boxes. Bird Packaging stresses service as its main selling point; this includes custom box sizes, printing, and fast delivery. According to Charles Bird, “If a prospective customer just wants boxes, we send him to Domtar.” In effect, Bird Packaging has carved out a niche for itself, dealing with customers who require different types of services, along with the actual box. 

Although Bird Packaging expected sales of $1.9 million in 2006, Bird estimated that the sales attributable to the present machine were only $400,000, since this represents its production capacity on a one-shift basis. If the new investment were not undertaken, this sales level would remain constant in real dollar terms, but would grow by the full inflation rate in nominal terms. If the new machine was purchased, Bird expected sales to increase by $400,000 in real terms over the next five years, but even he admitted that this outcome was far from certain. 

Materials were approximately 55 percent of sales, and were expected to remain at the same percentage regardless of sales volume. Bird estimated that manufacturing overhead was currently 10.7 percent of sales; 80 percent of this overhead (0.086 of sales) was fixed, and 20 percent (0.021 of sales) was variable. Labour costs were considered 100 percent variable, and were expected to fall from 12 percent of sales to 10 percent of sales. This labour savings results from a decrease in time required for setup and an increase in speed of production runs. Fewer people would be needed to run the new machine at higher production rates. 

Selling expenses were currently 10.7 percent of sales, of which 80 percent is fixed and 20 percent is variable (similar to manufacturing overhead). Administrative overhead was budgeted at $33,200 for 2006 and was considered by Bird to be totally fixed. 

Bird Packaging was subject to the small business tax rate of 20 percent and was expected to qualify for this reduced rate over the life of the investment. 

The new machine would cost $120,000 plus installation costs of $10,000. The company used five years as the expected life for all equipment purchases. Bird estimated that the new machine could be sold for $120,000 at the end of the five-year period. The salvage value was expected to remain the same as the purchase price because there are few technological advances in this type of machinery and any depreciation on the machine would be offset by price increases due to inflation. The salvage value of the old machine was $17,000. Assume a capital cost allowance rate of 30 percent. 

The minimum required rate of return for the firm was estimated between 15 and 20 percent, depending upon the expected future rate of inflation and interest costs selected. 

The last federal budget predicted that inflation would peak at 6 percent in 2006 and would then fall continuously to between 3 and 5 percent in 2007.

Bird prided himself on the company’s ability to fill orders much more quickly than competitors. The new machine would enable the company to improve its service in this area. The new machine would also provide a boost to the morale of Bird Packaging’s employees, who would benefit from both the change and the increased ease of operation. Workers tended to identify with the company, so when production ran smoothly, job satisfaction was increased. 

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Should Bird buy the new machine?