for prof matildah only

Running Head: FINAL EXAM 1

CASE ANALYSIS 1 2

1. Issue Identification

Preparation of the budget is the basic problem in this case, while the immediate problem is to choose the best alternatives between the three proposals, which should be based on the cost and manpower utilization. The implication of the problem is that for the budget to be prepared, the cost of replacing the outdated machine must be determined using the capital employed. The main root of the problem is that the milling machine is outdated causing the sales revenue to decline since it is incurring huge maintenance costs. Donovan is faced with making a decision on whether to build a general purpose milling machine, buy a special purpose numerically controlled milling machine or buy a general purpose milling machine.

2. Key Success Factors

Some of the key factors to the success of the organization include

1. Better quality control

2. Cost leadership

3. Productivity

4. Existing idle capacity

5. Marketing

6. Finances

7. Strategic focus

8. profitability

9. Availability of in-house expertise

9/10

3. Alternatives

The alternatives include building a general purpose milling machine at a cost of $212,500, buying a special numerically controlled milling machine at an initial cost of $625,000, or purchasing a general purpose milling machine costing $295,000.

5/5

4. Quantitative Analysis

Cost of building a general purpose milling machine (relevant costs):

The allocated administrative costs amounting to $12,000 are irrelevant costs.

Calculating the cost of buying a special controlled milling machine:

The labor cost at $15 per hour is irrelevant

Calculating the cost of buying a general purpose milling machine:

PLEASE HAVE A LOOK AT THE YEARLY CASH FLOW

Analysis of General Purpose Equipment vs Special Purpose

Yearly cash flows:

Comparing building or buying the general purpose milling machine, the initial cost of building the machine is lower, hence buying the general purpose machine option is ignored.

To obtain the budget for building a general purpose milling machine or buying a special purpose milling machine, we calculate the net present value of each option

PLEASE HAVE ALOOK AT THE CORRECT COST ANALYSIS AND NVP

Note: Fixed overhead and administrative costs are irrelevant.

10/40

5. Qualitative Analysis

The company operations in some of its branches are not performing well. The parts division, which has been in operation for 10 years, has seen its profits decrease since 2010. Many divisions operations are affected by the economic conditions hence it is important to evaluate the current situation of the economy before undertaking a major capital-intensive project.

Since each division performance is measured individually, management should be able to evaluate their performance by comparing budgeted sales and expenses with the actual figures. Using the capital expenditure estimates of the division, Kevin will be able to evaluate if the division will be able to finance the new milling machine based on the option selected.

Decision making based on whether to buy or build the milling machine and which type of milling machine will depend on the initial cost of acquiring the milling machine. The availability of excess production capacity available to produce a general purpose milling machine provides an avenue for the company to produce its own high-quality product using the available resources and workforce. Given that the company will be able to save on maintenance costs associated with the old milling machine, as well as insurance costs, it is advisable to build a general purpose machine in-house, which would cost less compared to buying a special milling machine.

10/30

PLEASE HAVE A LOOK AT THE QUALITATIVE ANALYSIS

Build General Purpose Machine:

• risk of lost sales–machine will take 6 months to complete. Presently

there is idle capacity but this may change over the life of the project

• while division is considered to have expertise there is no "guarantee"

(an outside supplier would have a guarantee)

Buy General Purpose Machine:

• Provided some kind of supplier guarantee or warranty

• machine immediately available

• no firm expertise necessary to buy as opposed to build a general

purpose machine

Buy Special Purpose Machine:

• guarantee/warranty should be available

• extensive training required to operate milling machine-what happens

when operator leaves company?-additional costs will be incurred to

hire and then train replacement operator(s)

• is cash available for financing the investment?

• impact on ROI and bonus

• due to capital nature of East Divsion, it may not be appropriate to

evaluate management on ROI since it may inhibit goal congruence,

i.e., the division may make short-run decisions to improve ROI at the

expense of long-run company objectives.

6. Recommended Course of Action

I recommend building a general purpose milling machine (OK) since its initial costs and also net present value is lower compared to buying the milling machine or buying a special purpose milling machine. It is also advisable to take into consideration the availability of expertise able to build the general purpose machines and also the fact that the company has idle capacity.

5/5

7. Circumvention of Potential Problems

The recommendation did not take into account the insurance cost reduction, although it was stated that the cost of insurance for the special purpose machine was higher than that of the general purpose machine. The time frame for building the new general purpose machine is 6 months which was not incorporated in the calculation of net present value but which does not affect the outcome of the decision made. 5/5