Lee Manufacturing Capital Budgeting Analysis In 2004 David Lee started Lee Manufacturing, 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. David's 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. David's 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. Lee's barbecues have been well received. Revenue and profits have grown steadily. Based on the recommendation from his sales and marketing department Mr. Lee is considering broadening his product line by adding a new product line of Lee 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. Lee 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 $37.500. 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 $46.90 per barbecue. They would be sold to retailers with a suggested retail price of $69.95. This would provide retailers with a target margin of 33%. The barbecues would be sold by the company's existing sales force to its cxisting customer base. Unit sales are forecast at 2,500 in year 1,5,000 in year 2, 6,500 in year 3, 8,000 in year 4, and then increasing by 1,000 cach 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 $65,000 per year. Variable costs for materials (sheet aluminum, grills, handles wheels, etc.) is expected to be $15.50 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 $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 be sold then for $27,500. Maintenance of the Strong equipment would cost $5,000 per year. Since the Strong equipment is more efficient the variable labor cost would be $9.00 per barbecue. The Precision brand is less expensive. It will cost $95,000 plus an additional $8,000 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 $8,000 per year. The variable labor cost with the Precision brand equipment would be $9.75 per barbecue. The increase in working capital (accounts receivable and inventory) is expected to be $35,000 at the beginning of the project and will be the same for both machines. The company's cost of capital is 14% and its tax rate is 40%. Since Mr. Lee's production team believes that both brands of equipment will last for eight years David wants this analyzed as an eight year project. David 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. David has asked you to analyze his choices and give him some advice on which option would provide the best financial outcome for Lee Manufacturing Prepare an analysis and professional report for Mr. Lee. 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. Lee and why. Make sure that the letter is well organized and professionally written. Also make sure that the letter includes the following: The cash flows associated with the different equipment brands for each year of the project. 1. 2. 3. The PB period, Discounted PB, IRR, MIRR, and NPV for the two alternatives. Your recommendation of which brand of equipment should be purchased. Attach to your letter schedules that show your analysis and your work. You should submit two files. A Word file with your letter and an Excel file with your analysis. 4. Steve's Trucking Company - Capital Budgeting Analysis Steve is a contract carrier for the United States Postal Service. He has been hauling mail for nearly thirty years. His current contract is to haul mail between 20 cities in the eleven western states. Steve currently has a fleet of 16 tractors and employs over 20 drivers. He does not own any trailers as all of the trailers are owned by the Postal Service. Steve's drivers drive scheduled routes between the cities. The Postal Service has just awarded Steve an additional contract that will require Steve to purchase six new tractors. He competed aggressively for the contract and spent a total of $45,000 in costs to prepare and submit the bid. Steve has narrowed his decision of which truck to buy down to two choices. He can purchase Volvo tractors or Kenworth tractors. The Volvo tractors would cost $285,000 each where the Kenworth would only cost $255,000 each. Both models would be depreciated to zero over 5 years using straight line depreciation The Postal Service contract pays Steve $2.85 per mile. Costs associated with each new tractor include wages for the drivers at $80,000 per truck per year and regular service and maintenance at a cost of $1,750 per month per truck. Fuel costs vary as Volvo is more fuel efficient than the Kenworth. Assume the tractors will be driven 105,000 miles per year and diesel costs will average about $3.25 per gallon. The Volvo is expected to get 3.6 miles per gallon while the Kenworth will get 3.3 miles per gallon. Insurance and licensing is expected to cost $6,000 per truck per year and is the same for both trucks. Both models will require a complete engine overhaul at 300,000 miles and Steve estimates that this will be during the third year of ownership. The cost of an overhaul on the Volvo is estimated at $45,000 per truck while the cost on the Kenworth is estimated at $52,000 per truck. All other maintenance costs are believed to be the same for each tractor. Steve expects to keep the trucks for six years after which time he will sell them. He will not overhaul the tractors in year 6 as it will not increase their value. He predicts that he will be able to sell the Volvo's for $60,000 each, but the Kenworth will be worth only $50,000 cach Steve's cost of capital is 14%. The company is in the 34% tax bracket. When Steve got started in the business his first truck was a Volvo. While they cost more Steve believes that they are a better truck and he love's the sleek and powerful look of a Volvo. Because of this he is leaning towards buying the Volvo tractors. But after hearing that you have learned about capital budgeting in your Finance class at UVU he wants to take advantage of your expertise. Steve has asked you to analyze his choices and give him some advice on what he should do. Prepare an analysis and professional report for Steve that includes the following items: Determine the cash flows associated with the different trucks for each year of the project. Calculate the PB period, Discounted PB, IRR, and NPV for the two alternatives. Explain to Steve what the different methods mean and how he can use them to help him make a decision. Determine which tractor you would recommend that Steve purchase. Write a professionally written letter, plus attached Excel spreadsheet, that explains what analytical techniques were used, why those techniques where used, what the results showed, what you would recommend to Steve, and why. Make sure that the letter is well organized and professionally written. Submit the letter with attached schedules that show the details of your analysis Also, include your Excel spreadsheet with calculations 1. 2. 3. 4