Online Tutoring on Corporate Modeling
Introduction
Dixie Corporation is an established Australian Company. It currently is importing all its products from overseas. Recently the company observed that the conditions in the Australian economy are becoming more favorable towards producing the goods in home. And therefore before producing other products in the country, the company wishes to initiate with the shelving. Presently it is preparing two types of shelving Type A and Type B. The ‘Type A’ shelving is of superior quality while the ‘Type B’ shelving is of inferior quality. The company has also observed that the market of Type B shelving is decreasing and its selling price is depressed. The reason is that there are several overseas plants, which can produce lots of Type B shelving’s. Dixie’s presently intend to produce both of the shelving’s when they open the plant in Australia.
Problem Description
The problem presently in front of Dixie Corporation is to decide on the several dilemmas it is facing. The first decision it has to make is that whether even it should consider producing in home or shall continue importing products. Once that has been decided, it has to choose that whether both the shelving’s have to be produced in Australia, or it shall import Product B. Apart from them the corporation also needs to decide on the important matter of corporate modeling. It would allow the entity to evaluate the return and risk factors associated with the different options. For this the Net Present Value would have to be computed for every expected year of operations under both conditions.
Input Data
The input data that the entity has collected from the observations and market analysis provide that the company would have to make an initial investment of $ 331, 993. Apart the entity has estimated that the plant would be viable for at least 10 years in row after the investment. However, considering the several risk factors, the Dixie’s conservatively have decided to use the plant’s life as 6 years for evaluation task. The discount rate that is used by the company for conducting the financial analysis is 12% per year. The revenue chart on the basis of demand, expected annual growth and unit selling price has been presented as:
| Product | Year 1 Demand
(tons) |
Annual Growth | Unit Selling Price
($ per ton) |
| Type A | 5,400 | +10% | $1,315 |
| Type B | 2,100 | -15% | $1,260 |
These are the expected demand levels of the Type A and Type B shelving, but the entity has determined that the plant structured has a maximum capacity of producing 8000 tons per year in total. And this capacity applies to the total tons of Type A and Type B shelving’s produced by the corporation. The fixed cost for the production house has been expected to be $1,300,000 in the first year. The annual growth of this cost is expected to be +1% per year. The Unit variable cost has been expected to be fixed and is $1,100 per tons for both the type of shelving’s. The depreciation rate applicable to Dixie’s is a straight line depreciation of 1/6 value of the asset, which would reduce the asset to zero level in six years. The tax rate is 30%, due immediately. Dixie’s have clarified that they have substantial profit to absorb the benefits of any negative tax benefit from the project.
Decision already taken
Considering the low sales and the lower profitability on Type B shelving, the company has already decided that Type A shelving would be given priority. And, therefore any capacity left after Type A shelving’s demand have been met, is to be utilized for meeting the demands of Type B shelving.
Risk Modeling
For evaluating the risk factor inherent in the project, it is necessary to evaluate the optimistic and pessimistic views on the project. Further, there is also a requirement of carrying out a Monte Carlo Analysis to evaluate the values that the NPV can take.
The Dixie’s Corporation has further carried out a research to identify the figures and the ratios that would be applicable in case the conditions are extreme. The results have brought out that the discount rate is expected to be uniformly distributed between 10% and 14%. The growth on the Type A shelving is supposed to be normally distributed with a mean of 10% and a standard deviation of 1%. The Capital Investment is normally distributed with a mean of $960,000 and standard deviation of $25,000. Considering that the analysis has not covered the distribution hovering over the Type B shelving, it has been assumed in the models that the Type B shelving is not being produced.
Optimistic Model
An optimistic model is a kind of model in which the evaluator assumes that everything would go in the favor of the entity. This means that the capital investment of the company on plant would be the lowest at $935000, the discount rate would be at the smallest rate of 10%. Finally, the increase in demand of Type A shelving is expected to be 11%.
Monte Carlo Simulation
Finally once the optimistic and pessimistic models have been evaluated, it is a must that the Monte Carlo simulation is considered to complete the risk modeling. This is expected to bring out the total percentage of expected values. On the basis of Monte Carlo analysis carried out through 200 simulations the results are:
| Count | % of total | ||
| Negative NPV | 200 | 100.00% | |
| Positive NPV | 0 | 0.00% | |
Thus, the Monte Carlo Simulation presents that the % of times when the negative NPV is expected is 100%.
Assumptions
In the risk modeling the following assumptions have been considered:
- Dixie’s Corporation would not produce Type B shelving, since it has not determined the annual growth rate of its demand in its analysis.
- The company has adequate profits to absorb the negative tax liability.
Conclusion
The analysis of the revenue and risk models of the production plant brings out that initially the entity has appropriate prepositions, if the investment to be made is $331,993. And, even in this condition it is a must that the entity produces both the type of shelving’s. Since otherwise the entity would have to incur a loss of NPV of about 91.77%.
Apart the entity would have to make sure that in no case the investment is $935000 or $985000, or over these, as have been considered in the optimistic and pessimistic models. It is necessary, because if the investment is up to these levels the net present value from the plant would be negative even when the entity has everything else in its favor.
