1. Should the Silicone-X project be undertaken? Why/why not?
After completing the analysis and reviewing the NPVs and IRRs for each option, labor intensive and capital intensive, Soderberg should recommend that the Jacobs division move forward with production of Silicon-X using the labor-intensive option. The NPV and IRR methods make the same decisions if used for independent projects however, since these projects are mutually exclusive, the best NPV option should be used. In this case the NPV for the labor-intensive option is positive at twelve percent, sixteen percent and twenty percent while the capital option is only positive at twelve percent and sixteen percent. The labor-intensive option meets the expectations for both the company guidelines and Mr. Reynolds’ personal guidance for the Jacobs Division. The company guidelines state that a return of sixteen percent for new products or processes is expected and Mr. Reynolds guidance is that he “tended to look for at least 4 percent more than the company standard before becoming enthusiastic about a project.” With the labor-intensive option, the Silicone-X project should be undertaken. One of the key advantages that weigh in favor of undertaking the Silicone-X project, outside of the NPV evaluation, is that with the labor- intensive option, Silicone-X could be on the market within a year. With the capital-intensive option the plant will likely take “two years to get the plant on stream, and the first year’s operating volume was likely to be low-perhaps 700,000 pounds at the most.” So, with the capital option plant, the first two years would have zero production and the third year would have almost two thirds the plant as unused capacity. Soderberg states that he is unsure of the demand for Silicone-X and indicates that the demand could be as low as 500,000 pounds and as high as 2 million pounds. In the event that Silicone-X only generates demand of 500,000 pounds, the remaining two thirds of capital-intensive plant is wasted capacity. For the labor-intensive plant, if demand should drop, personnel could be laid-off reducing costs. The problem arises with the labor intensive plant if demand exceeds 1.5 million pounds. In the event of increased demand, increased production needs can be addressed with additional shifts or instituting a seven day operating schedule with three operating shifts. In both the labor-intensive and capital-intensive options, the break even point at a per pound price of $1.90 will likely occur in the first year of production which as stated earlier will occur within a year of the decision to move forward with Silicone-X. The labor-intensive option break even point is at 540,000 pounds which will likely be accomplished by the end of the first year of production. By contrast, the break even point for the capital-intensive option will be at 325,900 which, even in the best scenario, will occur a year after production would start at the labor-intensive plant. Soderberg is concerned with the introduction of competition and the pricing for Silicone-X. In industry, it is best to be first to the market with your product, and if this is not possible, then your product should be superior. In the case of Silicone-X, there is no patent protection and there is no foreseeable product that is superior, it is important that the company that manufactures this product for sale be first to the market. In this case, competition will likely take a year to gear up after the introduction of Silicone-X giving the Jacobs Division two years of competition free sales. After the initial 540,000 pounds, the remaining sales are profit. In the event that this product does not excel in the market place, the initial capital outlay for the labor-intensive option would not be lost as this equipment is very adaptable. This is not the case for the capital-intensive option, where this equipment would likely be sold at a...
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