Levelhead Company is considering the purchase of a new machine for the manufacture of its’ helmets. Levelhead has been manufacturing safety helmets for the past 15 years and has become one of the leaders in the industry. Their safety helmets comply with all the required specifications including strength, weight and fit for the construction industry. They are a little concerned that some of their competitors are coming up with lighter weight helmets that may prove popular, in particular in their Australian market, due to the hot weather that persists for much of the year. The new machine would allow them to produce these lighter weight helmets and they anticipate this would ensure they maintain their current market share in an increasing market.

The new machine would cost $1,000,000 and has an estimated useful life of 5 years. This is more than long enough in such a progressive industry as helmet manufacture where improvements are being made all the time. Whilst they are fairly sure that this machine purchase would be the right thing to do they have decided to employ you as an outside consultant to determine what would be the correct course of action for them to take. The machine will require initial installation costs of $10,000 and freight costs of $10,000. It would be able to be depreciated for taxation purposes using the straight-line method over its’ useful life. The company believes it will be able to sell the new machine at the end of the five years for $350,000. With this in mind for their accounting purposes they have decided to depreciate it straight-line down to the value of $350,000 over the five years. This new machine would replace an existing machine that was bought ten years ago for $600,000. It had an estimated useful life of 15 years and tax allowable depreciation for it is the straight-line method over the full 15 years. If they sell this old machine now Levelhead estimate they should be able to receive around $150,000 for it.

If the new machine is implemented, the company estimates that revenues will increase by the following amounts each year:

Years 1 - 3 $300,000

Years 4 - 5 $250,000

Cash costs are also expected to increase by an additional $60,000 each year as well as changes to their working capital requirements. This is expected to be a reduction in working capital by 20% of the revenue increases and would occur at the beginning of each year. As the revenues decline after year 3 Levelhead are wondering if it may be preferable to sell the machine after three years. They believe that if they do so they should be able to sell the machine for $450,000 at the end of year 3. This would also enable them to purchase a new machine at this time in order to keep up to date with any changes that may have occurred during the three years.

Levelhead have been preparing for an increased demand from their move into the New Zealand market. With this in mind they have stockpiled $200,000 worth of their existing safety helmets. On introducing the new helmet they are a little concerned that this stockpile will reduce in value. They had hoped to sell these helmets over the next two years, i.e. $100,000 each year. However if they introduce the new product they believe they will have to sell them at a reduced value over the next two years, i.e. $50,000 each year.

Levelhead Company is currently listed and trades with a relatively low beta of 0.65. Its’ taxation rate has been 30% for the last 5 years and it expects this to be maintained. The current risk free rate has been trading around 4.5% p.a. with the market trading at a 7% p.a. premium. Inflation is anticipated to be around 3% p.a., this is not included in the dollar estimates given in this analysis as they are all in 2005 dollar figures.

You are required to write a report to Levelhead Company discussing the options that they have. A full analysis of each option should be provided, this will include a complete financial analysis of each strategy. Please provide Levelhead with your analysis and recommendations in a report to the Managing Director, Mr Bob Temleh

[此贴子已经被作者于2005-10-4 19:56:39编辑过]