MPS was founded 10 years ago as a lawn care and snow removal company.  The business has been doing great and is profitable but for the past 3 years, the revenue has become stagnant and hasn't grown.  In fact, MPS is forecasting that the net income of the lawn care and snow removal business will start decreasing.  The net income for the fiscal year just ended is $2,000,000 and MPS expects the net income will decrease by $250,000 per year for the next 8 years if no changes are made.  In order to combat the expected decline in the lawn care and snow removal business, MPS would like to expand its business by manufacturing its own brand of lawn mower and snow blower for sale.  MPS believes that there is a market demand for high quality lawn mower and snow blower. To confirm their assumptions, they have hired a market research firm last year for $300,000 to conduct a market study.  The result of the study indicates that there is indeed a strong market demand for high quality lawn mower and snow blower.  MPS is now considering whether to build a manufacturing plant to manufacture their own brand of lawn mower and snow blower for sale.

 If MPS decide to pursue this project, the manufacturing plant would be built on a piece of land that is currently owned by the company.  The land is currently vacant and has been vacant for 10 years (since the company's inception).  If the company were to sell the land today, it could be sold for $2,700,000.  Another option is to rent the land out to another company.  If MPS were to rent it out, it could get $730,000 of rental income per year for the next 8 years. 

 

Based on the market research conducted last year, MPS has made the following assumptions with respect to the sales and the production cost of the lawn mower and snow blower 

The manufacturing plant will cost $1,400,000 to build and it belongs to a tax asset class with a CCA rate of 5%.  The equipment within the manufacturing plant that is used to produce and assemble the lawn mower and snow blower will cost $900,000, and it belongs to a tax asset class with a CCA rate of 40%.  The project is estimated to have a life of 8 years, and at the end of the project life, the manufacturing plant and the equipment is estimated to have a market value of $100,000 and $50,000 respectively.  The tax rate associated with this project is 40% and the cost of borrowing related to this project is 10%. 

 Like any manufacturing business, MPS will purchase raw materials before production and sale, giving rise to an investment in inventory and accounts payable as MPS does not pay for all of its purchases by cash right away.  It will maintain cash as a buffer against unforeseen expenditures and its credit sales will generate account receivable.  MPS has made the following assumptions relating to these items:

 Before MPS can start producing lawn mower and snow blower, they need to buy $300,000 worth of raw materials (nuts, bolts etc.) and they will pay for all of this with cash.

During Year 1, MPS forecast that 20% of the annual sales will be on credit, meaning the credit sales will not be collected at the end of Year 1, and will be collected in Year 2, leading to an AR balance at the end of Year 1.

During Year 1, all of the fixed production cost will be paid for by cash.  For the variable production cost, MPS estimated that it can defer $350,000 of payment to vendors at year end and pay for them in Year 2, leading to an AP balance at the end of Year 1.

During Year 1, after the production of lawn mower and snow blower has started, MPS determine that it should have $150,000 worth of finished goods (lawn mower and snow blower) on hand at all time to avoid potential stock out issue, leading to an inventory balance at the end of Year 1.

During Year 1, MPS determine that it should have a minimum cash balance of $100,000 at all time.

From Year 2 to Year 8 (the end of project life), the working capital level for each year is expected to remain the same as a % of sales as the one calculated in Year 1.

At the end of the project, it is expected that MPS can sell the remaining finished goods, raw materials (nuts, bolts etc) and all of its associated accounts receivable and payable that it has on hand to other companies.  However, it is unreasonable to expect that MPS can receive full value from the recovery of these working capital items.  A reasonable expectation is that these working capital items will get 20% of its original value during this liquidation sale.

 

Based on the information above, what is the best decision for MPS at this time?  Discuss the multiple options that are available to MPS at this time and support your answer with detail calculation of the project financial performance under each scenario.  Why you are recommending your particular option, which criteria you use to arrive at your decision and why the criteria you select is the most appropriate.

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Lawn Mower Year 1 Snow Blower 2,600 Year 1 Year 2 2,850 Sales (in units) Price for Year 1 is $300 per unit and the price is expected to increase by 3% per year Variable production cost for Year 1 is $180 per unit and this cost is expected to increase by 5% per year Fixed production cost for Year 1 is $200,000 and is expected to remain constant 4,100 Year 2 Year 3 4,400 5,600 Year 3 Year 4 5,800 6,100 Year 4 Year 5 6,000 5,600 Year 5 Year 6 5,850 4,800 Sales (in units) Price for Year 1 is $1,000 per unit and the price is expected to increase by 4% per year Variable production cost for Year 1 is $700 per unit and this cost is expected to increase by 5% per year Fixed production cost for Year 1 is $250,000 and is expected to increase by 6% per year Year 6 Year 7 4,900 4,000 Year 7 4,050 Year 8 3,200 Year 8 3,100 Lawn Mower Year 1 Snow Blower 2,600 Year 1 Year 2 2,850 Sales (in units) Price for Year 1 is $300 per unit and the price is expected to increase by 3% per year Variable production cost for Year 1 is $180 per unit and this cost is expected to increase by 5% per year Fixed production cost for Year 1 is $200,000 and is expected to remain constant 4,100 Year 2 Year 3 4,400 5,600 Year 3 Year 4 5,800 6,100 Year 4 Year 5 6,000 5,600 Year 5 Year 6 5,850 4,800 Sales (in units) Price for Year 1 is $1,000 per unit and the price is expected to increase by 4% per year Variable production cost for Year 1 is $700 per unit and this cost is expected to increase by 5% per year Fixed production cost for Year 1 is $250,000 and is expected to increase by 6% per year Year 6 Year 7 4,900 4,000 Year 7 4,050 Year 8 3,200 Year 8 3,100

Answer rating: 100% (QA)

MPS Expansion Options Evaluation MPS has three options 1 Continue with existing lawn care and snow removal business Base Case Expected net income decl... View the full answer