Red River Manufacturing (RRM) Ltd. is a manufacturer of snowmobiles and jet skis, which has been operating in Canada for over 50 years. It produces snowmobiles in Beausejour, Manitoba and jet skis in Langley, British Columbia and sells them both domestically and internationally. The company has been very successful financially, but the board of directors feels that these two segments are maturing and do not offer strong potential for future growth.

RRM is considering expanding its product line. One option is to produce small excavators, which will be sold primarily to construction and mining companies, farmers and ranchers, the military, and municipal governments. The company feels that this new product will draw upon existing strengths it has in small engine manufacturing, but it does realize it will be selling to a different market in which it has no sales experience.

A second option is to manufacture boat motors. This expansion will allow the company to remain in the leisure market and utilize its established selling network.

Expansion into either excavators or small boat motors will be an expensive undertaking and will require the construction of a new manufacturing plant. Bob Solomon has been assigned as the team leader of a group of engineers, accountants, and marketers responsible for investigating these new projects. Undertaking both is a possibility, but it would put great pressure on the companys management and its capital budget may not be sufficient.

Solomons team is instructed to complete a detailed analysis of the two expansion projects and report back to the Capital Budgeting Committee. The NPV approach, based on quarterly cash flows, is the primary method to be used, but the IRR and discounted payback are also required. They should make a recommendation on which project(s) to select including both the quantitative and non-quantitative rationale for their decision. This should include whether RRM has sufficient financial and management resources.

Excavators Project

RRM would have to build a new factory to manufacture excavators. The facility would have capacity to produce 11,000 units per year. The cost of the land would be $1,600,000 and the building $5,400,000. Equipment costing $11,000,000 would also be needed. It is expected that the project will have a life of 15 years at which time the company will reconsider its options. It is estimated that the land will be worth $3,500,000, the building $600,000, and the equipment $350,000 in todays dollars at the end of the projects life. The building and equipment have minimal salvage value due to their highly specialized nature. The building is subject to a CCA rate of 4 per cent and the equipment a CCA rate of 20 per cent. As real estate, the building is amortized separately in its own pool for tax purposes. The equipment is a busy class with numerous asset sales and purchases throughout the year. The corporate tax rate is 25 per cent.

In addition to property, plant, and equipment, additional net working capital will be required which will vary with sales. The NWC Turnover Ratio for this new operation is expected to be five based on quarterly sales.

Sales are estimated to be 2,900 units in the first year, but are expected to grow at approximately 18 per cent per year for the first five years before levelling out to two per cent growth as the company reaches maximum market penetration. Sales of excavators are seasonal and are expected to follow the following pattern:

January March	15%
April June	45%
July September	25%
October - December	15%

Construction and mining companies, farmers, and ranchers will purchase their units through local heavy equipment retailers, who will buy the units from RRM at a list price of $18,100. In addition to selling to retailers, RRMs sales force will sell directly to its military and municipal clients, who will receive a 10 per cent discount on the list price. RRM expects sales to its military and municipal clients to be 40 per cent of the total initially, but to fall to 25 per cent starting in Year 4.

The cost of goods sold are expected to be $15,700 per unit. Non-traceable factory costs are expected to be $780,000 per year. An additional $265,000 in administration costs related to the new plant will be incurred at head office annually.

Selling this new product will demand the hiring of a national sales manager at $170,000 per year and two regional sales managers (Eastern and Western Canada) at $70,000 each per year, who will be located in the corporate sales office and not at the plant. It is felt that eight additional sales people at a base salary of $40,000 would be needed to sell this new product. A commission equal to 20 per cent of unit gross profit is to be received by the national sales manager, who will distribute it to the two regional sales managers and the individual sales persons depending on how well they meet their quotas. The commission is based on the gross profit margin of the units sold to encourage sales to higher margin retail clients.

It is difficult to estimate, but it is expected that the company will have enough market power to raise prices by the inflation rate each year. All costs are also expected to increase by the annual inflation rate, which is estimated to average two per cent over the life of the project. Cash flows other than sales and costs of goods sold occur uniformly throughout the year.

1. Build an Excel workbook containing four separate worksheets: Excavator-NPV; Excavator Scenario Analysis