Camp Gear

Capital Budgeting Analysis

In 2004 George Kramer started Camp Gear, a company dedicated to manufacturing simple yet efficient propane camp stoves. The camp stoves are made of aluminum and are priced at the middle of the market. Camp Gears goal has always been to make a stove that cooks great food. This means, good quality parts, simple construction, even heat, no hot or cold spots, and a stove that will hold temperature, especially at the lowest settings. The most common complaint from camp stove users has always been that the stoves controls dont hold at lower settings. It is really hard to get consistent low heat from the burners. To fix this problem Camp Gear uses an efficient brass valve that is heavy duty enough to provide consistent temperatures at all settings. Camp Gears motto is high quality for a fair price. The company offers four basic camp stove models and a complete line of accessories. Camp Gears stoves have been well received. Revenue and profits have grown steadily.

Based on the recommendation of his sales and marketing department Mr. Kramer is considering broadening his product line by adding a new product line of small portable one burner stoves. These stoves would be small and light weight, ideal for those cooks that want something smaller than the standard two and three burner stoves. Mr. Kramer has asked his sales and marketing team to come up with a sales forecast for units and pricing. He has also asked his manufacturing team to come up with alternatives for the production of these one burner stoves including what equipment is needed and what the projected costs would be.

The sales and marketing team hired Advanced Marketing Consultants to conduct a market survey. The total cost for this consulting contract was $37,500 and the conclusion was that there was sufficient demand for the one burner stove product line. The initial model would be a mid-weight aluminum one burner stove. Eventually, two more models would be added, a smaller light weight version designed for backpackers and a heavy duty stainless steel model designed to be indestructible.

Based on the survey and their own experience the sales and marketing team has provided a sales forecast. The suggested price of the initial one burner stove is $11.99 per stove. They would be sold to retailers with a suggested retail price of $19.95. This would provide retailers with a target margin of about 40%. The one burner stoves would be sold by the companys existing sales force to its existing customer base. Unit sales are forecast at 12,500 in year 1, 18,000 in year 2, 22,000 in year 3, 25,000 in year 4, and then increasing by 2,500 each year thereafter. Sales and marketing expenses are expected to be 10% of total revenue.

The production team forecasts that the fixed costs needed for the one burner stoves production line will be $55,000 per year. Variable costs for materials (sheet aluminum, burners, fittings, handles, etc.) is expected to be $3.25 per unit. The variable labor costs will vary based on what equipment will be purchased.

There are two brands of equipment that could be purchased to manufacture the camp stoves. The first is made by the Strong Equipment company. The second is made by the Precision Industrial company.

The Strong brand is more expensive, but higher quality and more efficient. It will cost $125,000 plus an additional $9,000 for shipping and installation. The equipment would be depreciated to zero over 5 years using straight line depreciation. It is expected that the equipment would last for 8 years at which time it would then be sold for $27,500. Maintenance of the Strong equipment would cost $5,000 per year. The variable labor cost would be $2.55 per stove.

The Precision brand is less expensive. It will cost $90,000 plus an additional $5,000 for shipping and installation. The equipment would be depreciated to zero over 5 years using straight line depreciation. It is expected that the equipment would last for 8 years and would then be sold for $22,000. Maintenance of the Precision equipment would cost $7,000 per year. The variable labor cost with the Precision brand equipment would be $2.95 per stove.

The increase in working capital (accounts receivable and inventory) is expected to be $55,000 at the beginning of the project and will be the same for both machines. The companys cost of capital is 14% and its tax rate is 40%. Since Mr. Kramers production team believes that both brands of equipment will last for eight years he wants this analyzed as an eight year project.

Mr. Kramer has always believed in buying quality so he is leaning towards the Strong brand equipment. But after hearing that you have learned about capital budgeting in your Finance class at UVU he wants to take advantage of your expertise. He has asked you to analyze his choices and give him some advice on which option would provide the best financial outcome for Camp Gear.

Prepare an analysis

1. The cash flows associated with the different equipment brands for each year of the project.

2. The PB period, Discounted PB, IRR, and NPV for the two alternatives.

3. Your recommendation of which brand of equipment should be purchased.