Thompson Lake Manufacturing (TLM) Ltd. is a manufacturer of snowmobiles and jet skis, which has been operating in Canada for over 50 years. It produces snowmobiles in Gillam, Manitoba and jet skis in Savona, 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.

TLM 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. Sheba Jedidiah 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.

Jedidians 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 TLM has sufficient financial and management resources.

Excavators Project

TLM 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 CAD 1,600,000 and the building CAD 5,400,000. Equipment costing CAD 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 CAD 3,500,000, the building CAD 600,000, and the equipment CAD 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% and the equipment a CCA rate of 20%. 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 corporatrate is 25%.

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 18.0% per year for the first five years before levelling out to 2.0% growth as the company reaches maximum market penetration. Sales of excavators are seasonal and are expected to follow the following pattern:

January March	15.0%
April June	45.0%
July September	25.0%
October - December	15.0%

Construction and mining companies, farmers, and ranchers will purchase their units through local heavy equipment retailers, who will buy the units from TLM at a list price of CAD 18,100. In addition to selling to retailers, TLMs sales force will sell directly to its military and municipal clients, who will receive a 10.0% discount on the list price. TLM expects sales to its military and municipal clients to be 40.0% of the total initially, but to fall to 25.0% starting in Year 4.

The cost of goods sold are expected to be CAD 15,700 per unit. Non-traceable factory costs are expected to be CAD 780,000 per year. An additional CAD 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 CAD 170,000 per year and two regional sales managers (Eastern and Western Canada) at CAD 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 CAD 40,000 would be needed to sell this new product. A commission equal to 20.0% 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 2.0% over the life of the project. Cash flows other than sales and costs of goods sold occur uniformly throughout the year.

Small Boat Motors Project

The new factory to build small boat motors would last approximately 20 years and could produce approximately 25,000 units per year. The land would cost CAD 1,250,000 and the building CAD 6,400,000. Production equipment worth CAD 7,900,000 would also have to be acquired. It is estimated that the land will be worth CAD 2,750,000 and the building CAD 1,350,000 in 20 years in todays dollars. The equipment will have a negligible salvage value. The building is subject to a CCA rate of 4% and the equipment a rate of 20%. The building is amortized separately in its own pool for tax purposes.

Additional net working capital will be required to support this project. The NWC Turnover Ratio for this new operation is expected to be six based on quarterly sales.

Sales are estimated to be 9,000 the first year but will grow at 12.0% a year till the end of Year 10 before levelling out. Sales will grow at 2.0% a year after that reflecting general growth in the industry. Major increments in capacity are not economical due to the nature of the production process, but the company feels production could be increased to as much as 32,000 units with improvements in work methods. Sales of outboard motors are seasonal and are expected to follow the pattern below:

January March	10.0%
April June	50.0%
July September	30.0%
October December	10.0%

Small boat motors would be sold through the same retailers that carry snowmobiles and jet skis. The selling price will average CAD 2,550 per unit. The cost of goods sold are expected to be CAD 2,200 per unit. Non-traceable factory costs are expected to be CAD 590,000 per year and an additional CAD 205,000 in administration costs related to the new plant will be incurred at head office annually. No new sales staff will be required, but sales people will receive a commission equal to 15.0% of the gross profit on each unit. It is expected that prices and costs will increase by the inflation rate over the life of this project.

To remain up-to-date with technology, a major overhaul of the product will have to be done at the end of the tenth year. R&D costs of approximately CAD 110,000 each year will be incurred prior to the introduction of the new model, and a CAD 1,300,000 overhaul of the production equipment will be undertaken near the end of Year 10 and will not interfere with factory production. The new equipment will be in the same CCA class as the other production equipment, and the R&D costs will qualify for a 15% investment tax credit each year.