Harding Plastic Molding Company

On January 11, 1975, the finance committee of Harding Plastic Molding Company (HPMC) met to dig eight swell budgeting couchs. Present at the meeting were Robert L. Harding, President and founder, Susan Jorgensen, comptroller, and Chris Woelk, interrogative sentence of look for & development. Over the aside five eld this committee has met whole(prenominal) month to consider and make final judgment on each(prenominal) told proposed with child(p) come onlays brought up for review during the period. Harding Plastic Molding Company was founded in 1954 by Robert L. Harding to produce plastic part and molding for the Detroit automakers.For the first 10 years of operations, HPMC worked solely as a subcontractor for the automakers, but since then has make strong efforts to diversify in an attempt to avoid the cyclical problems face up by the auto industry. By 1970 this diversification attempt had lead HPMC into the intersection of over 1000 different items, including kitch en utensils, camera housings, phonographic and recording equipment. It also led to an growing in sales of 500 percent during 1964 to 1974 prod. As this spectacular increase in sales was paralleled by a corresponding increase in outturn volume, HPMC was forced, in late 1973, to expand production facili link ups.This lay out and equipment expansion involved dandy expenditure of approximately Rs. 10. 5 cardinal and resulted in an increase of production capacity of about 40 percent. Because of this increase production capacity, HPMC has made a concerted effort to attract sensitive business, and consequently, has recently entered into contracts with a large toy firm and a study discount department store chain. While non-automotive related business has enceinte significantly, it still only represents 32 percent of HPMCs overall business.Thus, HPMC has keep to solicit non-automotive business, and as a result of this effort and its internal research and development, the firm has fo ur sets of mutually exclusive projects to consider at this months finance committee meeting. Over the past 10 years, HPMCs capital budgeting cost has evolved into a whatsoeverwhat elabo order procedure in which new proposals atomic number 18 categorized into three areas profit, research and development and sanctuary. Projects move into the profit or research and development area are evaluated by using present nurse techniques.Assuming a 10% opportunity cost, those move into the safety classification are evaluated in a more prejudiced framework. Although research and development projects have to receive favorable results from the present value criteria, in that respect is also a total dollar limit appoint to projects of this category, typically running about Rs. 750,000 per year. This limitation was imposed by Harding mainly because of the special availability of quality researchers in the plastics industry. Harding felt that if more bullion than this were allocated, We simply couldnt find the manpower to administer them properly.The benefits derived from safety projects, on the other hand, are not in terms of silver flows hence, present value methods are not used at all in the evaluation. The subjective approach used to evaluate safety projects is a result of the pragmatically difficult task of quantifying the benefits from these projects into dollar terms. Thus, these projects are subjectively evaluated by a management worker committee with a limited budget. All eight projects to be evaluated in January are classified as profit projects. The first set of projects listed on the meetings agendum for examination involves the utilization of HPMCs precision equipment.Project A calls for the production of mindlessness containers for thermos bottles produced for large discount hardware chain. The containers would be manufactured in five different size and colour combination. This project would be carried out over a three-year period, for the sales. Project B involves the manufacture of inexpensive photographic equipment for a national photography outlet. Although HPMC currently has excess plant capacity, both of these projects would utilize precision equipment of which the excess capacity is limited.Thus adopting either project would tie up all precision facilities. In humanitarian, the purchase of new equipment would be both prohibitively expensive and involve a time fit of approximately deuce years. Thus making these projects mutually exclusive. (The cash flows associated with these two projects are given in exhibit-1) Exhibit 1 CASH FLOWS social class Project-A Project-B 0 -75,000 -75,000 1 10,000 43,000 2 30,000 43,000 3 100,000 43,000 Year Project-C Project-D 0 -8,000 -20,000 1 11,000 25,000 Exhibit 2 coin FlowsThe second set of projects involves renting, computer facilities, over a one-year period to aid in client bearing and mayhap inventory overlook. Project C entails the evaluation of a customer billin g system proposed by Advanced Computer Corporation. Under this system, all of the bookkeeping and billing presently being done by HPMCs accounting dept. would now be done by Advanced. In addition to saving cost involved in book keeping, Advanced would add a more streamlined billing system and do a credit analysis of delinquent customers, which would be used in the prox for in-depth credit analysis.Project D is proposed by International Computer Corporation and includes a billing system similar to that offered by Advanced, and, in addition, an inventory control system that will keep track of all raw satisfyings and parts in stock and reorder when incumbent, thereby reducing the likelihood of material stock outs, which has become more and more frequent over the past three years. (The cash flows for these projects are given in exhibit-2).Exhibit 3 Cash Flows Year Projects-E Project-F 0 -30,000 -271,500 1 210,000 100,000 2 100,000 3 100,000 4 100,000 5 100,000 6 100,00 0 7 100,000 8 100,000 9 100,000 10 100,000 The third ratiocination that faces the financial directors of HPMC involves a newly developed and patented process for molding hard plastics. HPMC can either manufacture or market the equipment necessary to mold such plastics or they can sell the patent rights to Polyplastics Incorporated, the cosmeas largest producers of plastic products. (The cash flows for project E and F are shown in exhibit-3). At present, the process has not been fully tested, and if HPMC is going to market it itself, it will be necessary to compute this testing and begin production of plant facilities immediately.On the other hand, selling these patent rights to Polyplastics would involve only nipper testing and refinements, which could be completed within the year. Thus, a decision on the proper course of action is needed immediately. The final set of projects up for consideration revolved around replacement of some of the machinery. HPMC can go in one of the two directions. Project G suggests the purchase and generalization of moderately priced, extremely efficient equipment with an expected life of 5 years project H advocates the purchase of a similarly priced, although less efficient machine with life expectancy of 10 years.The cash flows for these alternatives are shown in exhibit-4) As the meeting opened, debate immediately centered on the well-nigh appropriate method for evaluating all of the projects. Harding suggested that since the projects to be considered were mutually exclusive, perhaps their commonplace capital budgeting criteria of net present value was inappropriate. He felt that, in examining these projects, perhaps they should be more concerned with relative profitability of some measure of yield.Both Jorgensen and Woelk concord with Hardings point of view, with Jorgensen advocating a profitability superpower approach and Woelk preferring the use of the profitability index would provide a benefit-cost ratio, directly implying relative profitability. Thus, they merely need to rank these projects and select those with the highest profitability index. Woelk agreed with Jorgensens point of view but suggested that the counting of an internal rate of return would also give a measure of profitability and perhaps be somewhat easier to interpret.To settle the issue Harding stated that the NPV, PI and IRR approaches would inevitably yield the same ranking order. EXHIBIT-4 Cash Flows Year Project-G Project-H 0 -500,000 -500,000 1 225,000 150,000 2 225,000 150,000 3 225,000 150,000 4 225,000 150,000 5 225,000 150,000 6 150,000 7 150,000 8 150,000 9 150,000 10 150,000 From here the discussion turned to an appropriate approach to the problem of differing lives among mutually exclusive projects E and F and projects G and H.Woelk argued that there really was not a problem here at all, that as all of the cash flows from these projects can be determined, any of the discounted cash flow s methods of capital budgeting will work well, Jorgensen, on the other hand, argued that although this was true, she felt that some stipend should be made for the fact that the projects being considered did not have check lives. HARDING PLASTIC MOLDING COMPANY QUESTIONS 1) Was Harding correct in stating that the NPV, PI and IRR unavoidably will yield the same ranking order? Under what situations mogul the NPV, PI, and IRR methods provide different rankings? Why is it possible? ) What are the NPV, PI and IRR for projects A and B? What has caused the ranking conflicts?Should project A or B be chosen? Might your answer diverseness if project B is a typical project in the plastic molding industry? For example, if projects for HPMC for the most part yield approximately 12 percent is it logical to assume that he IRR for project is of approximately 33 percent is a correct calculation for ranking purposes? (Hint Examine the reinvestment assumption rate) 3) What are the NPV, PI and IRR for projects C and D? Should projects C or D be chosen? Does your answer change if these projects are considered under a capital constraint?What return on the marginal Rs. 12,000 not used in project C is necessary to make one indifferent between these projects under a capital rationing situation? 4) What are the NPV, PI and IRR for projects E and F? be these projects comparable to(predicate) even though they have unequal lives? Why? Which project should be chosen? Assume these projects are not considered under a capital constraint. 5) What are the NPV, PI and IRR for projects G and H? Are these projects comparable even though they have unequal lives? Which project should b e chosen? Assume that these projects are not considered under a capital constraint.