1) How much importance should be given to the energy cost situation? Michael Burton’s proposal to expand into new energy efficient products is justified by increasing interest in the public and private sectors to reduce energy costs. At the highest level of government, the Obama administration has tied the US economy’s energy policy with its future success and competitiveness with other global powers. In a speech on June 2009, President Obama specifically mentions the Energy Department’s plans to implement “…aggressive efficiency standards for common household appliances – like refrigerators and ovens – which will spark innovation, save consumers money, and reduce energy demand.”1 Sarah Max from Money magazine (2010) also mentions that there are over 100 state programs that offer additional incentives for home energy efficiency. She points out that there 6 times as many programs offered by utility companies as well.2 In all, home consumers are being highly incentivized through rebates and tax credits to make home energy improvements— including the purchase of energy efficient appliances. Presumably Tesca Work’s new product will meet the Energy Star standards established by the EPA and DOE. According to the Energy Star achievements report for 2010, American households purchased around 200 million Energy Star qualified products that year (3.5 billion since 2000).3 The energy cost situation is one that the Tesca Works cannot ignore in their product development and marketing strategies. 2) Forecast the project’s cash flows for the next twenty years. What assumptions did you use? This project’s cash flows are projected over twenty years based on three assumptions or scenarios for the product’s demand: Weak, Average, and Strong. Each scenario’s variables are outlined in the Table 1 below: Table 1: Assumptions / Scenarios4
Demand Probability Price/Unit Units Sold/Year Weak 20% $1,450 42K Average 50% $1,500 41K Strong 30% $1,550 40K
Additional project data, outlined in Table 2 below, is used to calculate the Annual Operating Cash Flow for each scenario:
Obama, B. (2009). Remarks by the president on energy. Retrieved from http://www.whitehouse.gov/the_press_office/Remarksby-the-President-on-Energy/ 2 Max, S. (2010). 5 things you need to know about…energy rebates. Money, 39(6). p.3. 3 Energy Star Overview of 2010 Achievements. (2011). Retrieved from http://www.energystar.gov/ia/partners/publications/pubdocs/2010%20CPPD%204pgr.pdf?1e82-578b 4 Rowan, E.G. (2012). Tesca Works. Case Study for BUS-635. University of LaVerne, p.1-4.
Table 2: Annual Operating Cash Flow Summary
Data Name Annual Revenue Labor @ $250/unit Parts @ $300/unit Selling General & Administrative Compressor Cost (MC-004) @ $275/unit Compressor Warranty @ $156/unit Refrigerator Warranty @ $274/unit Depreciation Expense Taxes Net Loss / Income Annual Operating Cash Flow Note Price x Units Weak $60.9M -$10.5M -$12.6M Demand Scenarios Average $61.5M -$10.25M -$12.3M -$8M See Question 4 for details on compressor selection. Per Unit Cost = NPV of $40 over 5 years Per Unit Cost = NPV of $70 over 5 years $11M x 20 years (Straight Line) Marginal Tax Rate = 40% With Depreciation AddedBack -$11.5M -$6.55M -$11.51M -$11.28M -$6.40M -$11.23M -$550K $0 (because EBIT < $0) -$360K $190K -$598K $897K $1.45M -$1.3M $1.95M $2.5M 4
Strong $62M -$10M -$12M
-$11M -$6.24M -$10.96M
Note: All calculations above begin in Year 3, when actual production and selling of the product occurs.
In order to calculate Total Cash Flow per year, we need to combine a) the total amount of initial investment costs4 slated from Year 0 to Year 3 along with b) the amount of Annual Operating Cash Flow for the entire length of the project. Furthermore, Tesca needs to allocate funds (equivalent to 8% of annual revenue*) to Net Working Capital (NWC) in Year 2 so that the manufacturing of the refrigerators can begin in Year 3. In each scenario, NWC was recovered at the end of the...
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