Introduction

Robert Smiles has recently been hired as the CEO of Business Machines, Inc. Previously he had been the marketing manager for a large manufacturing company and had established a reputation for identifying new consumer trends. Business Machines Inc. is a California-based high speed industrial printers manufacturing company. The company is well known for manufacturing large, heavy-duty high speed industrial printers at a reasonable cost. One of its greatest achievements is that its high speed industrial printers can be easily modified or customized for different applications.

The company is considering an expansion of its current product line to include high-efficiency printers. Mr. Smiles feels that due to high energy prices, consumers will be more willing to consider purchasing new efficient printers.

Profile of Business Machines

Business Machines, Inc. was established by the Smith brothers in 1880 as the Logging Saw Company. The firm started manufacturing large steam saws to serve the logging industry which processed lumber. Their customers were construction companies that provided housing for the population increase in California. The Smith brothers quickly realized that the times were changing. They started looking for the technologies that would keep them at the forefront of their field of business. In 1915, the Smith brothers decided that they needed to make high speed industrial offset machines as replacements for the saws. They realized that the logging industry was not viable anymore and that high speed industrial printers were starting to serve the same purpose.

The company started making high speed industrial printers in the early 1950s. Business Machines then opted to produce commercial printers. It was an easy decision to make since the two products would use common parts and the customers were local hospitals, schools, and governments. Starting in the 1950s the commercial appliances business accounted for about 50% of Business Machines revenues.

The high-efficiency printers

Mr. Smiles arranged a meeting with the firms top management and the chief design and the chief manufacturing engineers to propose a new product. Mr. Smiles presented an argument that more individuals in the United State and Canada would be willing to purchase newer high-efficiency printers with the energy star rating because people are becoming more environmentally conscious. The new high-efficiency printers are more efficient and environmentally friendlier. Also, the recent increase in electricity costs seems to be long lasting. This is an opportunity to get people hooked on environmentally friendly appliances as he put it.

The proposal under consideration is for the introduction of new, energy star high-efficiency printers. To distinguish Business Machines from other manufacturers, the proposal included details about the quietness of operation that need to be developed.

Mr. Phillips and Mr. Lopez, the two engineers, enthusiastically and quickly pointed out that the needed technology could be based on the companys high speed industrial printers. The framework currently used for building the high speed industrial printers can be modified to work for appliances at a low cost. The marketing vice president, Mr. Chen, pointed out that the marketing analysis could be done quickly and at a reasonable cost. At this point, Mr. Smiles charged the participants in the meeting to produce a financial plan for the development and production of the high-efficiency printers.

Consumer Home Printing

Most people purchase ink jet printers and keep them for a very long time or until they stop working. Recently, most computer companies started educating people about the efficiency of new printers and began offering rebates on the most efficient consumer models. These approaches increased public interest. This renewed the publics interest in low ink-consuming printers.

The decision

Three weeks later, the vice presidents presented the sales and cost forecasts shown in the exhibits. The information presented contains the cost of production, financing information, and warranty cost estimates. In addition, there were two options for the print head in the high-efficiency printers. The PC 004 is more expensive to install, but has a lower warranty cost. The TP L12 is cheaper to install, but has a higher warranty cost. Which print head should be used?

The analysis

Mr. Smiles noticed that there is an abundance of enthusiasm about entering the high-efficiency printers building business, but his cautious nature made him seek a more neutral analyst. This is your responsibility. You have been hired by Business Machines to analyze the proposal to build the high-efficiency printers and provide recommendations to Mr. Smiles. The issues that need to be addressed in your report are the following:

1. How much importance should be given to the energy cost situation? The energy cost situation should be given special consideration. The entity may be able to use the information to determine which kit the entity should produce or whether the project should be completed at all. It will aid in determining the cost and provide the entity with the ability to analyze both kits. The cost of the situation will assist in determining the risk of each project. This will assist the entity in making an informed, objective decision based on data rather than an "overabundance of enthusiasm."
2. What is the projects cost of equity?
3. What is the appropriate discount factor to use for evaluating the high-efficiency printers project? To calculate the discount rate, the first thing to be identified is the discount rate. For discount rate, the cost of capital needs to be calculated. The cost of capital is the Weighted Average cost of capital for the electric motor project. Since the project is having a Debt to Equity ratio of 0.5 , the ideal company used for comparing could be General generators whose D/E is 0.5. So Beta = 1.5, Cost of Equity = Rf + Beta* MRP = 3% + 1.5*(6.5%- 3%) = 8.25%

Cost of debt = 6.5% (since company's debt is at the high end of debt range) WACC= kd*Wd*(1-t) + ke * We = 6.5%*1/3 * (1- 35%) + 8.25%*(2/3) = 6.91% So Discount factor = 1/(1+ Discount rate) = 1/1.0691 = 0.9353

4. Which of the two print heads should be used in the high-efficiency printers if you decide to go ahead with the project and why?
5. Forecast the projects cash flows for the next eight years. What assumptions did you use? Use MACRS depreciation for this case. For assumptions we used tax rate of 35 % to calculate the tax returns along with the taxable amounts for all years , and also we used straight-line depreciation with regard to depreciating the investment in the project over time , the we assumed the Market value of equipment at Year 8 is 0 because after 8 years the designs become obsolete .
6. Use the appropriate capital budgeting techniques to evaluate the project.
7. Use the average demand scenario to evaluate the sensitivity of the projects NPV with respect to sale price of the high-efficiency printers and the cost of the print head.
8. Based on the scenario and sensitivity analysis you performed above, comment on the overall riskiness of the project.
9. Would you recommend that Business Machines accept or reject the project? What is the basis for your recommendation?