Problem 1:

Moora Inc.

Due to the increasing energy costs in the US, Jackie Moora is anxious. The old machine her company has been using to manufacture steel support beams for the construction industry served the company well over the past 5 years. And she expected the machine to do the same for the next 7 years. At which point she was expecting to replace the machine with another one. However, Jackie is concerned that higher cost of energy may reduce the profitability of their operations.

Currently, for the most recent fiscal year, sales have been 2M per year, and all costs pre-tax are 1.5M per year. Of these costs, direct labor associated with the existing machine is $300,000, energy costs are 500,000, and depreciation is 300,000 (expected for another 5 years). The existing machine was purchased for 3M and is expected to have no resale value at the end.

While sales and salaries are expected to increase at the rate of inflation of 5% per year for the foreseeable future, energy costs outpace inflation and are expected to grow at 15% for the foreseeable future. Demand for the support beams is quite elastic due to competition from foreign producers, meaning that the company cannot raise prices for their products above and beyond the 5% inflation rate.

As an alternative, Jackie Moora is looking for another option. She is considering whether it would be better to buy a wholly new machine. The current price is 4.5M, but the machine would have the effect of dropping energy costs to 200,000 for the next year. These costs, again, would grow at the 15% growth rate for the foreseeable future. The new machine would be expected to last 10 years, depreciated straight-line over that period, and have no resale value at the end of that period.

Tax rate is 25% and since this is a small enterprise with a lot of risk, discount rate used in 15% per year. Jackie and the team of directors are seeking your help with the analysis of all possible scenarios.

1) What should the company do? Should the company stay in business or shut down operations?

2) If they should stay in business, should they keep the old machine, or buy the new one? Jackie and the team of directors encourage you to think carefully about how to approach the analysis. They need the decisions to be backed by present value analysis and numbers. All possible scenarios of operations need to be considered