Question: Wilcox is a familyowned company that has
Wilcox is a familyowned company that has been making microwaves for almost 20 years. The company’s production line includes 10 models, ranging from a basic model to a deluxe stainless steel model. Most of its sales are through independently owned retailers in medium-sized towns in central Canada, giving the microwaves an image of high quality and price. However, industry sales have been stagnant and those of Wilcox have been falling in the past two years due to the Asian brands. Currently Wilcox sells 75,000 units per year at an average price of $120 each with variable unit costs of $60 (of which materials is $30). As a result Wilcox is operating its plant at about 75% of a one-shift capacity, although in its “golden years†in the early 1990s it was operating at 75% of a two-shift capacity.
In the spring of 2016, Oh Mart, a chain of large supermarkets, approached Wilcox’s CEO and asked about the possibility of producing microwaves for them. The microwaves will be sold under the Oh Mart house brand, called Top Line. They are offering a five-year contract that could be automatically extended on a year-to-year basis, unless one party gives the other at least three months’ notice that it does not wish to extend the contract. The deal is for 24,000 units per year with a unit price of $90 each. Oh Mart does not want title on a microwave to pass from Wilcox to Oh Mart until the microwave is shipped to a specific Oh Mart store. Additionally Oh Mart wants the Top Line microwaves to be somewhat different in appearance from Wilcox’s other microwaves. These requirements would increase Wilcox’s purchasing, inventorying, and production costs.
In order to be able to give an answer to Oh Mart, knowing that they had no room to negotiate, Wilcox managers gathered the following information:
1. First-year costs of producing Top Line microwaves:
Materials (includes items specific to Oh Mart models) ………………………..$40
Labour (same as with regular microwaves) ………………………………………20
Overhead at 100% of labour (50% is variable; the 100%
rate is based on a volume of 100,000 units per year) ……………..…………..20
Total unit cost …………………………………………………………………………………$80
2. Related added inventories (the cost of financing them is estimated to be close to 15% per year):
Materials: …………………………………………………….two-month supply (a total of 4,000 units)
Work in process: …………..1,000 units, half completed (but all materials for them issued)
Finished goods: ……………….500 units (awaiting next carload lot shipment to an Oh Mart
central warehouse in Concord, Ontario)
3. Impact on Wilcox’s regular sales. Wilcox’s sales over the next two years are expected to be about 75,000 units a year if it forgoes the Oh Mart deal, based on the CEO’s estimates after launching a new “top of the line†microwave. If Wilcox accepts the deal, it would lose about 5,000 units of the regular sales volume a year, since its retail distribution is quite strong in Oh Mart market regions. These estimates do not include the possibility that a few of Wilcox’s current dealers might drop its line if they find out that Wilcox is making microwaves for Oh Mart with a lower selling price.
Instructions:
Form groups of three students to complete the following requirements.
Requirements:
1. Determine if the proposal by Oh Mart will increase Wilcox’s net income in the next year.
2. Calculate the total value of the contract (suppose there is no renewal after the fifth year).
3. On the basis of the net present value criterion, should Wilcox accept the offer?
4. Estimate the strategic consequences of accepting the proposal (consider the current situation of the industry, Wilcox positioning, image, distribution, and production issues).
Answers to Exercises in Compound Interest (Exercise 20-16):
The general approach to these exercises centres on a key question: Which of the four basic tables in Appendix A should be used? No computations should be made until this basic question has been answered with confidence.
1. From Table 1.The $5,000 is the present valuePof your winnings. Their future valueSin 10 years will be:
S = P(1 + r)n
The conversion factor, (1 + r ) n , is on line 10 of Table 1.
Substituting at 6%: S = 5,000(1.791) = $8,955
Substituting at 14%: S = 5,000(3.707) = $18,535
2. From Table 2. The $89,550 is a future value. You want the present value of that amount. P = S ÷ (1 + r ) n . The conversion factor, 1 ÷ (1 + r ) n , is on line 10 of Table 2. Substituting,
P = $89,550(0.558) = $49,969
3. From Table 3. The $89,550 is a future value. You are seeking the uniform amount (annuity) to set aside annually. Note that $1 invested each year for 10 years at 6% has a future value of $13.181 after 10 years, from line 10 of Table 3.
4. From Table 3. You need to find the future value of an annuity of $5,000 per year. Note that $1 invested each year for 10 years at 12% has a future value of $17.549 after 10 years. Sn = $5,000 F, where F is the conversion factor
Sn = $5,000(17.549) = $87,745
5. From Table 4. When you reach age 65, you will get $200,000, a present value at that time. You need to find the annuity that will exactly exhaust the invested principal in 10 years. To pay yourself $1 each year for 10 years when the interest rate is 6% requires you to have $7.360 today, from line 10 of Table 4.
Pn = Annual withdrawal (F)
200,000 = Annual withdrawal (7.360)
6. From Table 4. You need to find the present value of an annuity for 10 years.
At 6%: Pn = Annual withdrawal (F)
Pn = $50,000 (7.360)
Pn = $368,000 At 20%:
Pn = $50,000 (4.192)
Pn = $209,600, a much lower figure
7. Plan B is preferable. The NPV of plan B exceeds that of plan A by $980 ($3,126 – $2,146): Even though plans A and B have the same total cash inflows over the five years, plan B is preferred because it has greater cash inflows occurring earlier
Transcribed Image Text:
S, = Annual deposit (F) $89,550 = Annual deposit (13.181) $89,550 %3D Annual deposit $6,794 13.181 $200,000 Annual withdrawal = $27,174 %3D 7.360 Plan A Plan B Year PV Factor Cash PV of Cash Cash PV of Cash at 6% Inflows Inflows Inflows Inflows 1.000 S(10,000) $(10,000) S(10,000) $(10,000) 1 0.943 1,000 943 5,000 4,715 2 0.890 2,000 1,780 4,000 3,560 3 0.840 3,000 2,520 3,000 2,520 4 0.792 4,000 3,168 2,000 1,584 5 0.747 5,000 3,735 1,000 747 $ 2,146 $ 3,126
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