Larcker Logging Company is preparing a bid for the right to clear-cut a large parcel of state timberland. The bid will include a fixed annual “stumpage fee” to be paid to the state, and company managers estimate that it will take 5 years to completely log the land. At the end of the contract, the company would be required to perform cleanup, including clearing the underbrush, removing logging waste, and replanting the area with Douglas fir, lodge pole pine, and tamarack trees. If the company fails to perform the cleanup, the state would impose a fine. In the past, the fine amounts have been much less than the cleanup costs. However, public concern has been growing about the failure of companies to replant state timberland. Estimated revenue and costs and other relevant information follows:
Bid for annual stumpage fee ............... $300,000
Number of truckloads per year .............. 1,300
Tons per truckload ................... 20
Revenue per truckload ................... $1,750
Variable cost per truckload ................. $200
Annual fixed production costs ............... $150,000
Selling and delivery cost per ton of logs ............ $50
Cost of cleanup (paid at the end of five years) ........ $1,700,000
Fine (paid if cleanup and replanting is not undertaken) ........ $1,000,000
Income tax rate .................... 30%
Required rate of return ................. 15%

The following questions will help you analyze the information for this problem. Do not turn in your answers to these questions unless your professor asks you to do so.
A. Suppose you are working as an intern in the accounting department. The chief accountant has asked you to develop a net present value (NPV) analysis for this contract using a spreadsheet and ignoring inflation. You assume that the company will clean up the site at the end of the contract.
B. When you present the spreadsheet to the accountant, he asks you to revise the NPV analysis to assume that the company will pay the fine instead of performing the cleanup.
C. Identify as many business risks as you can for this contract.
D. What factors would you vary in the NPV calculations as part of a sensitivity analysis? Explain.
E. Analyze the potential ethical implications of paying the fine instead of performing the cleanup:
1. Who would be affected by the company’s decision?
2. Would it be wrong for the managers to pay the fine instead of performing the cleanup? Identify the values you use when answering this question.
3. Suppose the state legislature is considering a change to impose larger fines on companies that do not perform the cleanup. Should this business risk affect the managers’ decision?

Turn in your answers to the following.
F. The accountant has asked you to draft a memo to the managers about whether the company should submit a stumpage fee bid of $300,000. Use the information you learned from the preceding analyses when drafting the memo.
G. In your answer to Part F, how did you treat the costs of cleanup versus the fine? Explain the factors you weighed and the values you used to make your decision. Are these values consistent with your own personal values?

  • CreatedJanuary 26, 2015
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