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Michael Burton has recently been hired as the CEO of Tesca Works, Inc.




Michael Burton has recently been hired as the CEO of Tesca Works, Inc. Previously he;had been the marketing manager for a large manufacturing company and had established;a reputation for identifying new consumer trends. Tesca Works Inc. is a California-based;generator manufacturing company. The company is well known for manufacturing large;heavy-duty generators at a reasonable cost. One of its greatest achievements is that its;generators can be easily modified or customized for different applications. Also, Tesca;Works currently builds commercial appliances.;The company is considering an expansion of its current product line to include;refrigerator and maybe, sometime in the future, consumer appliances. Mr. Burton felt;that due to high energy prices, consumers will be more willing to consider purchasing;new efficient appliances.;Profile of Tesca Works;Tesca Works, Inc. was established by the Smith brothers in 1880 as the Logging Saw;Company. The firm started manufacturing large steam saws to serve the logging industry;which processed lumber. Their customers were construction companies that provided;housing for the population increase in California. The Smith brothers quickly realized;that the times were changing. They started looking for the technologies that would keep;them at the forefront of their field of business. In 1915, the Smith brothers decided that;they needed to make generators as replacements for the saws. They realized that the;logging industry was not viable anymore and that generators were starting to serve the;same purpose.;The company started making generators in the early 1920s. Tesca Works then opted to;produce commercial appliances. It was an easy decision to make since the commercial;appliances would use common parts with the companys generators and the customers;were local hospitals, schools, and governments. Starting in the 1950s the commercial;appliances business accounted for about 50% of Tesca Works revenues.;The Refrigerator;Mr. Burton arranged a meeting with the firms top management and the chief design and;the chief manufacturing engineers to propose a new product. Mr. Burton presented an;argument that more individuals in the United State and Canada would be willing to;purchase newer appliances because people are becoming more environmentally;conscious. The new appliances are more efficient and environmentally friendlier. Also;the recent increase in electricity costs seems to be long lasting. This is an opportunity to;get people hooked on environmentally friendly appliances as he put it.;The proposal under consideration is for the introduction of a new, energy star;refrigerator. To distinguish Tesca Works from other manufacturers, the proposal;2;included details about the convenience, large shelves in the doors, high volume water and;ice dispensers, efficiency, and quietness of operation that need to be developed.;Mr. Phillips and Mr. Lopez, the two engineers, enthusiastically and quickly pointed out;that the needed technology could be based on the companys generators. The framework;currently used for building the generators can be modified to work for appliances at a low;cost. The marketing vice president, Mr. Chen, pointed out that the marketing analysis;could be done quickly and at a reasonable cost. At this point, Mr. Burton charged the;participants in the meeting to produce a financial plan for the development and;production of the refrigerator.;Consumer Appliances;Most people purchase appliances and keep them for a very long time or until they stop;working. Some get them when they purchase a home and do not think about them.;Recently, most power companies started educating people about the efficiency of new;appliances and began offering rebates on the most efficient consumer models. These;approaches increased public interest. This renewed the publics interest in low powerconsuming appliances.;The Decision;Three weeks later, the vice presidents presented the sales and cost forecasts shown in the;exhibits. The information presented contains the cost of production, financing;3;information, and warranty cost estimates. In addition, there were two options for the;compressor in the refrigerators. The MC 004 is more expensive to install, but has a;lower warranty cost. The TS L12 is cheaper to install, but has a higher warranty cost.;Which compressor should be used?;The Analysis;Mr. Burton noticed that there is an abundance of enthusiasm about entering the;refrigerator building business, but his cautious nature made him seek a more neutral;analyst. This is your responsibility. You have been hired by Tesca Works to analyze the;proposal to build the refrigerator and provide recommendations to Mr. Burton. The;issues that need to be addressed in your report are the following;1. Use the appropriate capital budgeting techniques to evaluate the project.;4;Exhibit 1 Sales forecasts;The forecasts are based on projected levels of demand. The firm could face weak;average, and strong demand. All the numbers are expressed in todays dollars. The;forecasted average inflation per year is 3.0%.;Demand level;Weak;Average;Strong;Probability;25%;45%;30%;Price per refrigerator;$1,375;$1,575;$1,600;Units sold per year;40,000;42,500;43,000;Labor cost per refrigerator;$250;Parts;$300;Selling General & Administrative;$10,000,000;Average warranty cost per year per refrigerator for the first five years is $75. The present;value of this cost will be used as a cost figure for each refrigerator. Afterwards, the;refrigerator owners will become responsible the repairs.;The refrigerators can be produced for eight years. Afterwards, the designs become;obsolete.;Exhibit 2 Compressor costs;Compressor choices;Compressor model number;CM - 004;TS - L12;Price per compressor and installation;$280;$260;Average annual warranty cost per year for five;$40;$50;years. Afterwards, the refrigerator owner will;become responsible the repairs*.;The chosen compressor will be installed in every refrigerator and will become a cost;figure for each unit produced.;* The compressor manufacturers are not providing Tesca Works with any warranty.;However, Tesca Works will provide warranty to its customers. After the initial five;years, the refrigerator owners may purchase extended warranty from any insurance;company that offers such packages.;5;Exhibit 3 Investment needs;To implement the project, the firm has to invest funds as shown in the following table;Year 0;$14 million;Year 1;Production and selling of commercial appliances starts;MACRS depreciation will be used.;To facilitate the operation of manufacturing the refrigerators, the company will have to;allocate funds to net working capital (NWC) equivalent to 10% of annual sales. The;investment in NWC will be recovered at the end of the project.;Exhibit 4 Financing;The following assumptions are used to determine the cost of capital. Historically, the;company tried to maintain a debt to equity ratio equal to 0.50. This ratio was used;because lowering the debt implies giving up the debt tax shield and increasing it makes;debt service a burden on the firms cash flow. In addition, increasing the debt level may;cause a reduced rating of the companys bonds. The marginal tax rate is 35%. All the;numbers are expressed in todays dollars. The forecasted average inflation per year is;3.0%.;Cost of debt;The companys bond rating is roughly at the high end of the A range. Surveying the debt;market yielded the following information about the cost of debt for different rating levels;Bond rating;AA;A;BBB;Interest cost range;4.5% ~ 5.5%;5.25% ~ 6.5%;6.5% ~ 9%;The companys current bonds have a rating of A.;Cost of equity;The current 10-year Treasury notes have a yield to maturity of 3% and the forecast for the;S&P 500 market premium is 6.5%. The companys overall is 1.3.;analysis;Company;Tesca;Works;1.3;Over all;Debt to;0.5;equity;Percentage of 50;income from;generators;Electrics;Plus;Universal;Power;1.4;0.3;General;Generator;s;1.3;0.5;45;90;95;6;International;Generators;1.6;0.45;Generator;s;Inc.;1.2;0.35;85;85;1.35;0.25


Paper#30404 | Written in 18-Jul-2015

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