Introduction

Dixie Corporation is an established Australian Company. It currently is importing all its products from overseas. Recently the company observed that the conditions in the Australian economy are becoming more favorable towards producing the goods in home. And therefore before producing other products in the country, the company wishes to initiate with the shelving. Presently it is preparing two types of shelving Type A and Type B. The ‘Type A’ shelving is of superior quality while the ‘Type B’ shelving is of inferior quality. The company has also observed that the market of Type B shelving is decreasing and its selling price is depressed. The reason is that there are several overseas plants, which can produce lots of Type B shelving’s. Dixie’s presently intend to produce both of the shelving’s when they open the plant in Australia.

Problem Description

The problem presently in front of Dixie Corporation is to decide on the several dilemmas it is facing. The first decision it has to make is that whether even it should consider producing in home or shall continue importing products. Once that has been decided, it has to choose that whether both the shelving’s have to be produced in Australia, or it shall import Product B. Apart from them the corporation also needs to decide on the important matter of corporate modeling. It would allow the entity to evaluate the return and risk factors associated with the different options. For this the Net Present Value would have to be computed for every expected year of operations under both conditions.

Input Data

The input data that the entity has collected from the observations and market analysis provide that the company would have to make an initial investment of $ 331, 993. Apart the entity has estimated that the plant would be viable for at least 10 years in row after the investment. However, considering the several risk factors, the Dixie’s conservatively have decided to use the plant’s life as 6 years for evaluation task. The discount rate that is used by the company for conducting the financial analysis is 12% per year. The revenue chart on the basis of demand, expected annual growth and unit selling price has been presented as:

Product	Year 1 Demand (tons)	Annual Growth	Unit Selling Price ($ per ton)
Type A	5,400	+10%	$1,315
Type B	2,100	-15%	$1,260

 

These are the expected demand levels of the Type A and Type B shelving, but the entity has determined that the plant structured has a maximum capacity of producing 8000 tons per year in total. And this capacity applies to the total tons of Type A and Type B shelving’s produced by the corporation. The fixed cost for the production house has been expected to be $1,300,000 in the first year. The annual growth of this cost is expected to be +1% per year. The Unit variable cost has been expected to be fixed and is $1,100 per tons for both the type of shelving’s. The depreciation rate applicable to Dixie’s is a straight line depreciation of 1/6 value of the asset, which would reduce the asset to zero level in six years. The tax rate is 30%, due immediately. Dixie’s have clarified that they have substantial profit to absorb the benefits of any negative tax benefit from the project.

Decision already taken

Considering the low sales and the lower profitability on Type B shelving, the company has already decided that Type A shelving would be given priority. And, therefore any capacity left after Type A shelving’s demand have been met, is to be utilized for meeting the demands of Type B shelving.

The initial Net Present Value Model

When all the above considerations have been considered, the company would have the following NPV computation model.

Particulars		Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Demand of the products
Type A		5400	5940	6534	7187	7906	8697
Type B		2100	1785	1517	1289	1096	932
Total Demand		7500	7725	8051	8476	9002	9629
Sales (in tons)
Type A		5400	5940	6534	7187	7906	8000
Type B		2100	1785	1466	813	94	0
Total Sales (in tons)		7500	7725	8000	8000	8000	8000
Sales (in $)
Type A		7,101,000.00	7,811,100.00	8,592,210.00	9,450,905.00	10,396,390.00	10,520,000.00
Type B		2,646,000.00	2,249,100.00	1,847,160.00	1,024,380.00	118,440.00	–
Total Sales		9,747,000.00	10,060,200.00	10,439,370.00	10,475,285.00	10,514,830.00	10,520,000.00
Variable Cost		8,250,000.00	8,497,500.00	8,800,000.00	8,800,000.00	8,800,000.00	8,800,000.00
Gross Profit		1,497,000.00	1,562,700.00	1,639,370.00	1,675,285.00	1,714,830.00	1,720,000.00
Fixed Cost		1,300,000.00	1,313,000.00	1,326,130.00	1,339,391.00	1,352,785.00	1,366,313.00
Depreciation		55,332.00	55,332.00	55,332.00	55,332.00	55,332.00	55,332.00
Net Profit before taxation		141,668.00	194,368.00	257,908.00	280,562.00	306,713.00	298,355.00
Tax @ 30 %		42,500.40	58,310.40	77,372.40	84,168.60	92,013.90	89,506.50
Net Profit after taxation		99,167.60	136,057.60	180,535.60	196,393.40	214,699.10	208,848.50
Result Variables
Cash Inflow		154,499.60	191,389.60	235,867.60	251,725.40	270,031.10	264,180.50
Present Value of Cash Inflows		137,946.07	152,574.62	167,885.90	159,976.04	153,222.90	133,842.06
Net Present Value		573,454.59

 

Since the capacity of the plant is less than the aggregate demand for Type A and Type B shelving, from third year priority has been given to meeting the demands of Type A shelving. The results provide that in these conditions, if the entity sets up its plant and produces both types of shelving, it would earn a Net Present Value of $573,454.59

Prioritizing Model

Dixie Corporation has realized from further surveys that they can also choose to produce only Type A shelving at the plant. It has been estimated that such a decision would result in decreasing of the initial capital investment by $30,000. However, no other effect is expected on the other cash outflows. In such conditions when only Type A shelving’s are produced, situational analysis be done, the NPV model would change to prioritizing model as follows.

Particulars		Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Demand of Type A Products		5400	5940	6534	7187	7906	8697
Sales (in tons)		5400	5940	6534	7187	7906	8000
Sales (in $)		7,101,000.00	7,811,100.00	8,592,210.00	9,450,905.00	10,396,390.00	10,520,000.00
Variable Cost		5,940,000.00	6,534,000.00	7,187,400.00	7,905,700.00	8,696,600.00	8,800,000.00
Gross Profit		1,161,000.00	1,277,100.00	1,404,810.00	1,545,205.00	1,699,790.00	1,720,000.00
Fixed Cost		1,300,000.00	1,313,000.00	1,326,130.00	1,339,391.00	1,352,785.00	1,366,313.00
Depreciation		50,332.00	50,332.00	50,332.00	50,332.00	50,332.00	50,332.00
Net Profit before taxation		(189,332.00)	(86,232.00)	28,348.00	155,482.00	296,673.00	303,355.00
Tax @ 30 %		(56,799.60)	(25,869.60)	8,504.40	46,644.60	89,001.90	91,006.50
Net Profit after taxation		(132,532.40)	(60,362.40)	19,843.60	108,837.40	207,671.10	212,348.50
Result Variables
Cash Inflow		(82,200.40)	(10,030.40)	70,175.60	159,169.40	258,003.10	262,680.50
Present Value of Cash Inflows		(73,393.21)	(7,996.17)	49,949.61	101,155.03	146,397.89	133,082.12
Net Present Value		47,202.25

 

This model of NPV calculation provides that when the entity is only producing Type A shelving, it would not be utilizing the complete capability of its plants. The net present value of the plant would be $47,202.25 in such conditions.

Comparative analysis

When the entity is only producing Type A shelving rather than both types of shelving’s, along with the gross profits and net profits, the figure of net present value would also come down. The comparative analysis of the NPV in both the conditions has been presented below.

Comparison
Net Present Value when both products are produced					573,455
Net Present Value when only Type A is produced					47,202
Difference in NPV					-526,252
% Difference in NPV					-91.77%

And, if the entity wishes to achieve the same net present value as it has been achieving when both the type of shelving’s were being produced, the initial investment would have to be brought down to negative $224, 259. The table below presents the computation, of the same.

To have the same NPV as is achieved when both products are produced

NPV expected shall equal Sum of present value of cash inflows less initial investment

NPV expected

=

Sum of PV of cash inflows

–

Initial Investment

573,455

=

349195.3

–

Initial Investment

Initial Investment

=

-224,259

 

Risk Modeling

For evaluating the risk factor inherent in the project, it is necessary to evaluate the optimistic and pessimistic views on the project. Further, there is also a requirement of carrying out a Monte Carlo Analysis to evaluate the values that the NPV can take.

The Dixie’s Corporation has further carried out a research to identify the figures and the ratios that would be applicable in case the conditions are extreme. The results have brought out that the discount rate is expected to be uniformly distributed between 10% and 14%. The growth on the Type A shelving is supposed to be normally distributed with a mean of 10% and a standard deviation of 1%. The Capital Investment is normally distributed with a mean of $960,000 and standard deviation of $25,000. Considering that the analysis has not covered the distribution hovering over the Type B shelving, it has been assumed in the models that the Type B shelving is not being produced.