Ahmed Abdur Rehman Yasser Shafqat Hamza Aurangzeb

The American market is increasingly being penetrated by Japanese Automobiles and the major American automobile manufacturers are losing their market share consistently. In 1975 American automotive manufacturers had held 80% share of the market with the Japanese holding 9%.Problem definition and case size-up The problem presented in this case pertains to the selection of the most appropriate option given the decision criterion of capital budgeting in finance. The case presents the scenario of the international automotive industry as of year 19981999. The equipment likely to be replaced is an oven employed in the cleaning the plant assembly’s skids. and improvements in production designs and plants. Specifically in the case the Ford Motor Company is shown to have undertaken a plan titled “Ford 2000” that projected a number of short-term and medium term goals. These goals were then translated into specific cost-cutting and revenue generating measures.S automobile manufacturers faced a saturated and increasingly price sensitive consumer market. At the St. These circumstances were prompting them towards alternate business strategies including mergers. changes in capital structures. In the given situation U. Thomas Assembly Plant (STAP) of Ford Motor Company the manager Michael Osborne is face with a replacement decision. By 1998 the American share had fallen to 60% while the Japanese had captured 30%. Skids were the mobile .

Another alternative under consideration was the ‘outsourcing’ of the cleaning process. Basically. it was basically a replacement decision. Essentially this would provide us with the incremental cash flows of the option. The new machine acquired was translated to the CD$ price using an exchange rate of 1. and was also deteriorative for the skins. repair and maintenance costs. By discounting the future cash flows we can obtain a practical idea of the increased wealth of the plant resulting from the decision. The depreciation method used was Reducing Balance .35. taxes etc. As an alternative the Seighers-Dinamec Fluidized Sandbed was a viable option. the costs were being saved and hence the cost savings were included in our calculation of Operating Cash flows. Then the incremental cash flows were included in the calculation of Operating Cash flow. depreciation. skids and workers charges. The environmental and workers related issues were also likely to go away with this replacement. These can then be compared to the costs and income currently being accrued plus the salvage value in case of disposal. The cleaning was done by heating the skids to a very high temperature in the above mentioned oven. with the new option. In addition. These skids after being used for a specific number of runs had to be cleaned. We calculated the cash flows of both the existing oven and the new oven. reducing their lives and causing additional repair costs. This would eliminate the cleaning department of STAP to a large extent but has its own strategic and cost concerns.‘platform’ on which all work-in-process was moved. Identifying cash flows in case of each alternative would include the purchase and installation costs. gas. the after-tax cash flow from the sale of old machine and the after-tax cash flow from the sale of spare parts. Analytical Approach: Given the four possible options in the case the analytical approach would be to identify the existing pattern of cash flows and compare them with the pattern of cash flows that would occur in case the alternatives are put in place. operating expenditure. Option 1: In option 1. Installation of this equipment would result in improved efficiency of the overall production process with lesser costs and increased efficiency. the fumes produced during the heating process were a cause of concern with the workers refusing to work because of the vile odor. The existing oven consumed substantial amounts of energy. income. The environmental effects were also likely to come under regulatory scrutiny in the near future possibly resulting in the oven being unusable. These cost savings include the difference in electricity. The initial outlay included the cost of purchasing the new machinery.

We were to continue using the old machine and acquire the same old costs. Then we multiplied this amount with the number of cars that were produced in 1998. The depreciation method used was Reducing Balance Method (10%) in accordance to CCA. Thus the loss in revenue has been incorporated in the calculation of operating cash flows. This was considered as a cost in our calculation for Operating Cash flows.Methods (10%) in accordance to CCA. the work refusals increased by 10% in the first year and we assumed that this figure remained constant throughout the 10 years. we calculated the revenue loss per worker arising due to work refusals. we decided to not include the repercussions of the new law. This gave us the revenue per car. Then we divided this total revenue by the number of employees in STAP (3000). To calculate this. If quantitative data was provided. Since. In this option. Revenue was taken to be 0 as the constant revenue for the 4 options will yield the same result. The cash flows considered are the normal costs that we would incur if we did not replace the old with the new oven. Option 2: Basically the option 2 was a ‘do-nothing’ option. we calculated per car revenue in 1997 by dividing the total revenue in 1997 by the total production of cars in 1997. Then. This gave us the revenue per worker. The depreciation was also calculated on the incremental basis. we were not able to incorporate this cost in our cash flow calculation. This gave us the total revenue in 1998 for STAP. we would have included this as our cost. The terminal cash flow includes the after-tax cash flow from the sale of old asset in the year 10. The terminal cash flow includes . insufficient information was given to us about stricter environmental regulation. Since the total number of skids replacement was not given in the data. The NPV comes out to be -101132041 in this case. Now we multiplied this by the number of work refusals (10% of 3000) to give us the total revenue loss due to work refusals.

we continue using the same old machine for 2 years then in the 2nd year. The outlay cost in 2nd year includes the purchasing price of new machine. Revenue was taken to be 0 as the constant revenue for the 4 options will yield the same result . gas. There is no terminal cash flow because the new machine is supposed to yield no cash inflow on disposal. Then the present value of cash flows is discounted back to year 0 to obtain their NPV. only incremental cash flows were considered which include. The depreciation method used in this case is Reducing Balance Method (10%) in accordance to CCA. after-tax cash flow from the sale of old asset and aftertax cash flow from the sale of spare parts. Then from the 3rd year onwards. The outlay cost in the 2nd year is discounted back to the year 0 using the WACC rate given in the writeup. electricity.35. workers and skids charges. depreciation. The exchange rate is the same.the after-tax cash flow from the disposal of the old asset. 1. Option 3 : In option 3. Revenue was taken to be 0 as the constant revenue for the 4 options will yield the same result. For the first 2 years. The revenue loss per worker is also considered for the first 2 years as calculated in option 2. we will buy the new machine because there is a substantial fall in the purchasing cost. we use the same costs that were to be incurred in the normal course of the business.

Option 4: In option 4. we assumed that we were selling the spare parts and old machine in year0. we basically outsource the cleaning entirely. The cash flows considered were depreciation savings. . gas savings and workers savings. Revenue was taken to be 0 as the constant revenue for the 4 options will yield the same result. The depreciation method used was Reducing Balance Method (10%) in accordance to CCA. The costs which we were incurring in this case was outsourcing cost of CD$10 per skid and the total number of skids were 57460. electricity savings. In this option. Initial outlay includes the after-tax cash flow from the sale of old assets and the spare parts. Workers savings in this case were 300000 as we were transferring our 4 workers to other areas of operation and savings per worker were 75000.

the NPV further falls to -12263851. Option 1: • By changing the depreciation rate to 15%. .Sensitivity Analysis: In all the options. we plan to change the depreciation rate to 15% and 5% and follow the effect of this change in the NPV of all the options.

the NPV further falls. the NPV increases to -866145. . Option 2: In option 2. if we increase the depreciation rate to 15%.• By changing the depreciation rate to 5%.

by decreasing the depreciation to 5%.If the depreciation rate is dropped to 5%. the NPV increases. then the NPV increases. . Option 3:In option 3.

In option 3. the NPV falls as the depreciation in this case was a cost saving. by increasing the depreciation to 15%. the NPV decreases. . Option 4: By decreasing the depreciation rate to 5%.

DECISION MAKING: However. revenue is a major aspect in decision making but since we weren’t given enough quantitative data to compute the revenue for the years in consideration so. the NPV increases. Our major decision influencing factors . we had to assume that it was 0 for all the options.By increasing the depreciation rate to 15%.

Other benefits that accrue from option 4 are not being liable to the new environmental law. less control. no human capital would be required for cleaning. . avoidance from the unhealthy relationships with workers’ unions and no repair and maintenance of skids. no work refusals. When the benefits and costs are reviewed in terms of the other available options. time management issues and uncertainty in cleaning costs per skid. the best option to opt for would be the one with the lowest negative NPV which turns out to be the option 4 as shown above.were the costs and the costs savings relating to all the 4 options. The major disadvantage of option 4 will be the dependence on the outsource company. it can be substantially justified that the option 4 yields the maximum benefit. In this scenario.