Prepare a breakeven point (BEP) for the top management of the firm. One thing they were sure to investigate was how quickly their investment would be recovered. Alan would use the following formula to determine the BEP for the PowrFlo 500 project:
BEP = Fixed Cost / (average sales price - marginal costs).
Alan sure had his work cut out for himself. He wondered just which option would be best for the firm. He also wondered how the firm would finance the more expensive options. It was time to crunch the numbers. Alan closed his office door and opened his laptop. It would be a long evening.
CONCLUDING COMMENTS
Making decisions under conditions of risk and by using leverage is difficult. Competitive forces would also have an effect on the decision. The proper course of action for a firm in such a situation is based on a number of considerations. This case can be used to help students to identify options before a final decision of action is made.
INSTRUCTIONS FOR ACCOUNTING AND FINANCE STUDENTS
After breaking into two or more groups complete the following (additional research is needed).
1) As a Group:Using Table 1 in the case duplicate the sensitivity analysis of the production points for the three options considered in the case by management: 1) Build an entire new production facility that would enable GEI to produce all of the products it needed, 2) Outsource production to build partners, 3) Expand the existing GEI facility to increase production. Construct these in a spreadsheet resembling the following (start with 100 units and increment the units upward by 100 units until you have calculated it to 30,000 units:
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Option 1
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Option 2
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Option 3
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New location
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Subcontract
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Expand
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Fixed costs
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$4,000,000.00
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$0.00
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$1,250,000.00
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Variable cost
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$55.00
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$255.00
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$155.00
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Total costs per proposal - fixed and variable
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Plan A
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Plan B
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Plan C
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Units
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New location
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Subcontract
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Expand
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100
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Calculate this
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Calculate this
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Calculate this
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200
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...
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...
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...
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...
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...
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30000
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2) As a group: Review the spreadsheet created above as a group and identify the production points where each option is attractive. Draw a chart (by hand or with spreadsheet software) showing the total cost lines of the three options. Plot total cost on the Y-axis and units of production on the X-axis for the three options. Identify the option that makes the most financial sense for the firm for 12,000, 13,000 and 28,000 units.
Net Present Value
3) As a group: Review Figure 3 that shows the cash flows estimated before and after Katrina. Calculate the NPV of cash flows for each stream of cash before and after Katrina using a discount rate of 9%. Remember that Figure 3 uses monthly cash flows and the discount rate is an annual rate. Use the following format (only part of Figure 3 is shown below).
Old Sales Estimate Old NPV of cash flow New Sales Estimate New NPV of cash flow
Date for PowrFlo 500 (units) sales price of $499.00 for PowrFlo 500 (units) sales price of $499.00
Oct-05 350 Calculate this 2700 Calculate this
Break Even Point
4) As a group: Use the fixed costs (Figure 1), the marginal cost per unit (Figure 1) and the average revenue per unit ($499.00) to calculate a Breakeven point in units for each of the methods (expand, outsource, new plant) in Figure 1.
Other opportunities
5) As a Group: How might the service plan to maintain generators be used by GEI to provide a future revenue stream?
Attachment:- CaseStudy-CapitalBudgeting.docx