Gus$$ Grills

Capital Budgeting Analysis

Ten years ago Gus Johnson started Gus$$ Grills, a company dedicated to manufacturing simple yet efficient gas barbecues. The barbecues are made of aluminum and stainless steel and are priced at the middle of the market. Gus$$ goal has always been to make a barbecue that cooks great food. This means, good quality parts, simple construction, even heat, no hot or cold spots, and a barbecue that will hold temperature from the lowest setting to the highest setting. Gus$$ motto is $$high quality for a fair price$.$ The company offers four basic grill sizes $($models$)$ and several options and accessories that can be added on to each model. Gus$$ barbecues have been well received. Revenue and profits have grown steadily.

Based on the recommendation from his sales and marketing department Mr$.$ Johnson is considering broadening his product line by adding a new product line of Gus$$ charcoal barbecues. These barbecues would be ideal for those cooks that like that distinct charcoal flavor or the nostalgia of barbecuing the old fashioned way. Mr$.$ Johnson 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 the charcoal barbecues 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 was $$40,500.$ The initial model would be a mid$-$sized kettle barbecue. Eventually, two more models would be added, a smaller version ideal for camping or apartment patios and a larger model for the serious cooks.

Based on the survey and their own experience the sales and marketing team has provided a sales forecast. The suggested price of the initial barbecue is $$87\mathrm{.}00$ per barbecue. The barbecues would be sold by the company$$s existing sales force to its existing customer base. Unit sales are forecast at $3,000$ in year $1,5,000$ in year $2,6,500$ in year $3,8,000$ in year $4,9,500$ in year $5,$ and then increasing by $1,000$ 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 charcoal barbecue production line will be $$85,000$ per year. Variable costs for materials $($sheet aluminum, grills, handles wheels, etc.$)$ is expected to be $$42\mathrm{.}50$ 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 lids and bowls of the barbecue. The first is made by the Strong Metal 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 $$145,000$ plus an additional $$15,000$ for shipping and installation. The equipment would be depreciated to zero over $7$ years using straight line depreciation. It is expected that the equipment would last for $8$ years at which time it would be sold then for $$37,500.$ Maintenance of the Strong equipment would cost $$6,000$ per year. Since the Strong equipment is more efficient the variable labor cost would be $$15\mathrm{.}00$ per barbecue.

The Precision brand is less expensive. It will cost $$100,000$ plus an additional $$11,000$ for shipping and installation. The equipment would be depreciated to zero over $7$ years using straight line depreciation. It is expected that the equipment would last for $8$ years and would then be sold for $$22,000.$ Maintenance of the Precision equipment would cost $$8,000$ per year. The variable labor cost with the Precision brand equipment would be $$16\mathrm{.}50$ per barbecue.

The increase in working capital $($accounts receivable and inventory$)$ is expected to be $$40,000$ at the beginning of the project and will be the same for both machines. The company expects the working capital to decrease by $$40,000$ at the end of the project $($at the end of year $8).$ The company$$s cost of capital is $13\mathrm{.}5\%$ and its tax rate is $25\%.$ Since Mr$.$ Johnson$$s production team believes that both brands of equipment will last for eight years Gus wants this analyzed as an eight year project.

Gus 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. Gus has asked you to analyze his choices and give him some advice on which option would provide the best financial outcome for Gus$$ Grills.

Prepare an analysis and professional report for Mr$.$ Johnson. The report should be professionally written and include a letter $($single spaced$),$ plus attached schedules. The letter should explain what analytical techniques you are using, why you are using those techniques, what the results show, what you would recommend to Mr$.$ Johnson and why. Make sure that the leletter includes the following: