French considered the details of each option, keeping in Tony Bell

Thompson Rivers University

Dr$.$ Andrew Fergus

Thompson Rivers University

INTRODUCTION

It was another sleepless night for Brian French. As a new

father, French had grown accustomed to sleep deprivation,

but on this night, it was his business$-$not his newborn

daughter$-$that had him tossing and turning. French was

the president and co$-$owner of Peregrine, a Vancouver$-$

based manu

mind that for long$-$term projects he would use a discount rate

of $7\%.$

OPTION $1$: PURCHASE A NEW CNC MACHINE WITH CASH

Although it would be costly$,$ the idea of adding a third CNC

machine appealed to French. It would provide him peace of

mind that if there were a breakdown, jobs would continue

on schedule. French's preliminary research revealed that

the cost of the new equipment would be $$142,000.$ He also

estimated that there would be increased out$-$of$-$pocket

operating costs of $$10,000$ per month if a new machine were

brought online. After five years, the machine would have a

salvage value of $$40,000.$ Although Peregrine did not have

the cash readily available to make the purchase, French

believed that with a small amount of cash budgeting and

planning, this option would be feasible.

OPTION $2$: FINANCE THE PURCHASE OF A NEW CNC MACHINE

The company selling the CNC machine also offered a

leasing option. The terms of the lease included a down

payment of $$50,000$ and monthly payments of $$2,200$ for five

years. After five years, the equipment could be purchased

for $$1.$ The operating costs and salvage values would be the

same as option $1,$ the purchasing option. The company had

the necessary cash on hand to make the down payment for

the lease. With both the leasing and purchasing options,

the company had sufficient space to operate the new

equipment, and French believed he had almost all of the

right employees in place to execute this plan.

OPTION $3$: ADD A THIRD SHIFT

French and one of his co$-$investors had extensive experience

in the trucking industry and had seen firsthand the effect

of utilizing equipment around the clock. French believed

adding a third shift could unlock a lot of value at Peregrine,

and it could be done at a low cost. Adding a third shift would

involve moving several existing employees to work the night

shift and would also mean hiring some new employees.

Although French believed that in time he may add a full

third shift to increase overall capacity, his initial plan was for

the night shift to run as a "skeleton crew" with the primary

purpose of keeping the CNC machines operational for $24$

hours. He believed that adding a third shift would produce

the same increase in revenue as adding a new CNC machine

to his existing shifts. He estimated that adding a third shift

would create $$12,000$ in additional monthly out$-$of$-$pocket

operating costs, but no new machinery would need to be

purchased. Based on his trucking experience, French knew

this option would be difficult to execute, as there were major

safety and supervision challenges associated with running a

night shift.

MOVING FORWARD

French wanted to get moving on a solution and arranged

a conference call with his two co$-$owners. He knew his co$-$

owners would be eager to learn the numbers behind each

option, but he also knew that nonfinancial information would

be just as crucial in making a recommendation. Before the

call, French sat down at his desk to fully analyze the options.

ASSIGNMENT QUESTIONS

Without using any numbers, identify the strengths and

weaknesses of the three options identified by French.

Are there any other options French should consider?

Compute and compare the net present value and payback

period of each option.

Make a recommendation for French.

Rounding to the nearest $1\%,$ at what discount rate does

leasing produce a higher net present value than paying

cash?