In December 2020, John Howard, CEO of Summit Plastics, was considering the purchase of a Husky automated injection molding machine. The Husky would replace older semiautomated machines and would offer improvement in quality and some additional capacity for expansion. Given the size of the proposed expenditure of $1.96 million, John was seeking a careful estimate of the project's costs and benefits and, ultimately, a recommendation of whether to proceed with the investment.

The Company

Summit Plastics specialized in the production of high quality plastic products for use in automotive equipment. The company had acquired a reputation for quality products. Its products included seat bases and door trim panels for cars. Customers were increasingly insistent about product quality, and Summit Plastics' response had reduced the defect rate of its products to 10 parts per 100,000. This record had won the company quality awards from major car manufacturers including Ford, Mazda, Toyota, and Hyundai and had resulted in strategic alliances with these firms. Summit Plastics and these car manufacturers exchanged technical personnel and design tasks. In addition, the car manufacturers shared important market-demand information with Summit Plastics, which increased the precision of the latter's production scheduling. In certain instances, the car manufacturers had provided cheap loans to Summit Plastics to support capital expansion. Finally, the company received relatively long-term supply contracts from these car manufacturers and had a preferential position for bidding on new contracts. Summit Plastics, located in Sterling Heights, Michigan, was founded in 1994 by John's grandfather, George Howard, a mechanical engineer, to produce plastic parts for the automobile industry. Summit Plastics grew slowly but steadily initially; however, its sales has grown at the annual rate of 18% for the last few years. The company was listed for trading on the New York Stock Exchange (NYSE) in 2010, and the John family owned 51% of the common shares of stock 2 outstanding. The company's beta was estimated at 1.66. Currently, the 3-month Treasury Bill yields 1.45%. The average market risk premium over the last 100 years was approximately 7%. The company's traditional hurdle rate of return on capital deployed was 8.5%, although this rate had not been reviewed since 2015. In addition, company policy sought payback of an entire investment within five years. At the time of the case, the market value of the company's capital was 45% debt and 55% equity. The prevailing borrowing rate Summit Plastics faced on its loans was 5.8%. The company's effective tax rate was about 28%, which reflected the combination of federal and local corporate income-tax rates. John, age 55, had assumed executive responsibility for the company five years earlier, upon the retirement of his father. Over the years, the Howard family had sought to earn a rate of return on its equity investment of 12%. The Husky Injection Molding Machine The new injection molding machine would replace six semiautomated injection molding machines that together had originally cost $600,000. Cumulative depreciation of $240,000 had already been charged against the original cost and six years of depreciation charges remained over the total useful life of 10 years. Summit Plastics' management believed that those semiautomated machines would need to be replaced after six years. John had recently received an offer of 220,000 for the six machines. The current six machines required 12 workers per shift (24 workers in total for two shifts per working day) at $15.00 per worker per hour, plus the equivalent of two maintenance workers (working one shift per day), each of whom was paid $16.00 an hour, plus maintenance supplies of $10,000 a year. John assumed that the semiautomated machines, if kept, would continue to consume electrical power at the rate of $22,000 a year. The Husky injection molding machine was produced by a company in Cleveland, Ohio. Summit Plastics had received a firm offering price of $1.83 million from the Wisconsin firm. The estimate for modifications to the plant, including wiring for the machine's power supply, was $100,000. Allowing for $30,000 for transportation, installation, and testing, the total cost of the Husky machine was expected to be $1.96 million, all of which would be capitalized and depreciated for tax purposes over six years. John assumed that, at a high and steady rate of machine utilization, the Husky would be worthless after the sixth year and need to be replaced. 3 The new machine would require two skilled operators (one per shift), each receiving $24.00 an hour (including benefits), and contract maintenance of $100,000 a year, and would incur power costs of $37,000 yearly. In addition, the automatic machine was expected to save at least $35,000 yearly through improved labor efficiency in other areas of the production. Certain aspects of the Husky purchase decision were difficult to quantify. First, John was unsure whether the tough collective-bargaining agreement his company had with the employees' union would allow him to lay off the 24 operators of the semiautomated machines. Reassigning the workers to other jobs might be easier, but the only positions needing to be filled were unskilled jobs, which paid $12.00 an hour. The extent of any labor savings would depend on negotiations with the union. Second, John believed that the Husky would result in even higher levels of product quality and lower defect rates than the company was now boasting. In light of the ever-increasing competition, this outcome might prove to be enormous, but currently unquantifiable, competitive importance. Finally, the Husky had a theoretical maximum capacity that was 30% higher than that of the six semiautomated machines; but those machines were operating at only 90% of capacity, and John was unsure when added capacity would be needed. There was plenty of uncertainty about the economic outlook in the U.S., and the latest economic news suggested that the economies of the U.S. might be headed for a slowdown. 4 Summit Plastics case questions

1. Please assess the economic benefits of acquiring the Husky machine (assume 8 hours per shift, 2 shifts per working day, and 210 working days per year). Provide numerical support and detailed calculation to support your answers.

a. What is the initial investment? (Note that an investment in Husky machine means a sale of semiautomated machines and any loss resulting from such a sale will have tax benefits).

b. What are the benefits over time?

c. What is the appropriate discount rate? Are there any problems or concerns with the companys using the traditional hurdle rate of 8.5%?

d. Does the net present value (NPV) warrant the investment in the Husky machine? (Note: The template Excel spreadsheet provided could help with the calculation)

2. How would the inability to lay off existing workers impact the project NPV and influence your recommendation?

3. Should John proceed with the project? Explain.