1. Should Friendly Cards purchase the envelope machine? If so, how?
Friendly Cards would be able to purchase the machine for $500,000. This machine would be able to produce the same amount of envelopes that it is currently purchasing for 1.5 million in 1987. The machine would last for an estimated eight years. As given in the table below there will be some additional costs in more warehouse space and labor. After you compute the savings and costs you will gain a positive cash flow of $218,000 in savings.
Exhibit 4 (Estimated Annual Savings in thousands) from case Savings| $1,500|
Total exp| $149|
Increase in Profit before tax| $351|
Increase in income tax @ .38| $133|
Increase in profit after tax| $218|
Friendly Cards should purchase the envelope machine. It will be able to reduce its bank loans by $218,000 dollars a year from the savings, which will increase its retained earnings by $218,000 a year. This will lower all three of the ratios that the bank has put restrictions on Friendly Cards for the next eight years. In 1988 the bank loan/receivables will reduce from .9 to .88, liabilities/equity will reduce from 4.04 to 3.77, and interest-bearing debt/equity will reduce from 2.62 to 2.43 (See Exhibit 1 for all other changes in following years). Friendly Cards will not have to put up any extra capital to purchase the envelope machine...