Valley Forge Plastics - THE FIRM VALLEY FO‘iGE PLASTiCS...

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Unformatted text preview: THE FIRM VALLEY FO‘iGE PLASTiCS MAKE OR BUY "ll we do Cch'lth to produce the 10* and l? in pipe intt‘rnally, it tiould solve our ovcr'stalling problem,” Phillip Walker, owncr or Valltéy l’orggt‘ Plastics, rcmarkod to Helen Riggms, the plant manager “l'm reluctant to lay anyone oll’or ewn L'Hl hack hours, lt'5a not good business and its not the right thing to do tin can be at all avoided," Phillip Walker had no intrintions ol Starting; ltlS own lirm in 1962 SlItU’ graduating from college in 1954 he had woi l\'('(l tor /\ YV Pipc, a (Millpillly hascd in VZillL‘)’ Forge, Pcnnsylvania, In January [062 lll(' timnpany do (‘idt'd to rclotatt; to Ohio, and Walker wcnt also, Walkvr and llle Wit}; wart: quite unhappy in Ohio, mainly bcc‘nusc they felt So distant from lltt‘ll‘ l'Cl'dllVCS, ncarly all ol" whom were lot‘ated around Valley t-‘orgc, In May 01' 1962 hi) dcriidcd to movc back to Vallcy Forge and 5:,t.nt ltlS own pipc compam/ (ltlllC a hold dt-cision, wally, for a man with thrcc L'llllr drcn and a {Ourth on the way, Walker lt‘ll lrc nndcrstood the mariut’ac‘turing Shh” ol lltC piping husr neas "lilSKltf and out " He recognized, howcvcr, that in orch to he Sin - ccsstul hc nc-cdcd r‘iarkcting and financial expertise, and ht: workcd very hard to Strengthen himscll in thcsc areas By his own admission Walker madc "many rnistakcg" during thc first 18 months, hut nonctho less, the busincss surged ahead. By the third year it was t‘lcar not only that the company would he sucu‘sflul, but that it had the potential to prosper, Ami prospcr N ha, Valley Forge (VF) Plastics operates on [/1 acrcs and employS (H people, in fiscal year l99l sales totaled nearly $25 million dcspitc a nationwide recassion and thv l‘righly Competitive nature ol thc piping husincss l24 f’ARl IV (’l‘xl’Il/tl llLIl‘itJHllJC Walker tllll'llilllt‘t» his success to two factors sen/ice and dedication to qmim, \fjl'fllfi many firms are tioi‘iceriied \Vllll the quantity ol’ pipe they produce, iielit ti om the start Walker was dedicated to manulacttiring,l the best quality at pipe pessible "ll’ we achieve quality the quantity Wlll take tuiie (ll ilsell,” he olteii tells his employees The company also prt'iVides ext epiionai .‘w( ivitt- ‘v’l' keeps an unusually large volume and {UN lion lll inventoin it' all tunes and r‘riaiiitains a relatively large fleet til triit ks As a result the t oinpany can [ill an order quite quickly Such last deliveiy means that distributers VF sells to~ 7 many ol' whom are rit’itit’mally known wlii'iltgsaleis Oi budding iiiateiialtr are able to keep their in, ‘t’t‘tiltity low A PROBLEM OF SIZE ’l he hull: (it ilxe t’iiiri's sales comes from PVC pipe, which is riiaiiily used in iesidmilial and tomrnercial plumbing and government sewer sysr twins this pipe t times in many dillerent sizes, and sales depend in part (in ciistoirieis Viewn’ig the firm as a "lull line producer " That is, a sales man is more likely to win an account il‘ a distributor is eonvmt ed that the inaniilat tiiier (an prorriptly deliver various sizes ot’pipe as needed '1 his typically means that a producer can quickly till orders for the most commonly used mixes ot PVC pipe; that is, pipe Willi diameters ol 3 in , t} in , and :~; in Hoinetiint‘s, hovtiever, a distributor is interested in to in, and “pm pipe as well Vt has never produced these sixes internallybecause Walls er tell that annual sales volume was too low toiustity the start~tip cost, It a customer does request such pipe, Vl' will typically buy it [mm 3 mm ppmm who does iii/inulaeture the desired sizes Walker has never can; fully armiuyed whethei this is a good policy, and he thinks now is the time. to do so, espeti ally given the tirrn’s stalling situation. As he sees it, there are two main advantages to producing the lllelll ,md 134m ppe internally, First, VF avciids the expense t‘ilbiiying the pipe [mm another firm, Vl‘ pays 45 cents per pound for this pipe plus another :2 cents per pound in distribution costs to get the pipe to VF's customers iimi gC-Hmt; price is 56 cents per pound A second advantage is that the company’s stalling problem would be helped, ’ ‘l‘liough dollar sales have increased slightly in the last two years, the increases have not l<€P1 “P Wllh ltillitlion. Walker realized six rnoi'iths ago that the [inn is overstalled by two employees the orders simply aren't mut- it) keep all the iiii‘t3tlttt't101"i workers busy lull time. He thinks this could continue, given notorily the state ol‘the economy but also the increase in industry compellllfin in its entire 2€1iiyear history, WC firm has never been lorced to even cut any workers hours, let alOIlC la)’ Someone Oil, And Walker has decided that he Won‘t start now (ASE 2| V/‘tltEY FORCE l‘lASl'ICB I25 WALKER'S ESTIMATES \«Vallier tjan‘t he certain, of course, what tutuie sales. Ut the ltlittt and 13‘ in, pipe will he He linds it helpful to thinl; in terms (itseeiiariosi, and he has devised a set of estimates shown in Exhibit t in addition, two salespeople itiiiit'ilziiiit’d that {teet'iuiitia were lt'rill when some dlbltl'lbttth’S learned that VF does not produce it) in and Iii-r in pipe internally Ariiitiaiently these disll‘tlitltt'JI'S were t‘t’interned that Vt? would net he al’ile to tilt an order as; quiekly as they would lilie AS a result, these Si’ilesrnen argued, the entire amount \deI01d and ltttt JUSI the orders tor ttyin and t2 in pipe Walker if; unsure, what to make of [Itth "lust order” argument it the sales personnel are. t‘tirreet, then Vi could nearly double the liijures shown in Exhihit t hy produeing the turn and 127m pipe ltt'I‘ttitlSt" While he, can he'ieVe that SMITH) Sillt‘S have heen lost, Walter tinds it hard to believe that the volume is anywl’iere near what the salespeople t‘ltiirii I-‘nr the time being he (let idea to igzri: ire the [VisStItlIlW that order; have, heen lost lle wants time to lliVCStttldIt’ the tlaimS ot the sales personnel Wht), he helieveg, have a strong incentive to inflate any IDES The most inexpensive equipment that is capable tit pitidiit'ing the quality that Walker de5ires, (oats $600,000 and (tilt generate It million pounds of pipe per year For the purpose OI analysg Walker wrll .tthllttt,‘ straight line (,Itjtit‘fi'tttttt'ttt river the eightyear lite, ot the prniet t the value (it the et'iuipment after eight year; is a hit of ti problem Walla-r expect}: that it Will he worth til I 80,000 alter tam-:1, though he adnuts it (t itiltl he as low as $ t 20,000 THE ACCOUNTANT’S ESTIMATES The tirin’s accountant, Bot) Camper, has lltW’ClOpe‘tl a SCI oi nunihers th.it, in his View, “Strongly ltitltCatC‘)" in hourae production 15.71 “lie-ting pr'tipty stition,” (See E'diihit 2) Cooper (,‘Sttmitlt‘S it will cost iii) 0 rent; per pound to prodt ee the 104m, and I? in pipe internally He notetr, tlifit Vt? (an purchase the Sarrie pipe for fit} tents per pound from another inanu t‘aetur'er and ltiCtttE» another 2 C(‘t’tt‘i per pound to get the pipe to VFS grigionirjrg, "thug, Cooper argues, internal protilutitir’in results in an 8 () mm per pound [053 or $96,000 per \tear {tSStttttlttg I 2 million pounds at pipe As Walker tans these figures he Smilth as he notieea that Cooper uSed Walker'a sales estimates and annual sale-5:1 [)t'tfitiatttItttCS He won ders, though, ho accurate the: aet‘t’iuntant'g numhers really are. tor one thing, the estimates are hased on the "tritist likely” sale: trigurc: and (I0 not eOnsider the, other sales pt’ixaihililies In addition, Walker questions the apprupriatenegb’ of including depret iatiun, given that it lit» a nunt ash item, tor these and other reagents he decides to rethink the tiguret; the accountant has eompited, ' 126 PART lV CAPlTAl BUDGETING \t./all:ei' is cor‘iiloi'tablt With a number ol' the items listed in Exhibit 2. He believes it is quite ri'éasonable, tor example, to assume material costs Will be 32 cents per pound And, yes, the project would use two laborers and Will require plant spare and supervisory personnel Yet the firm has significant excess space and the equipment could be operated in an unoccupied area of the lactory In addition, Walker believes that the hrrn's plant manager could easily supervise tbeproject without allecting her elliciency in other areas Walker then retlects luither on his stalling situation Although it may not be good business, he is quite Comfortable with his deeision not to terminate any employees Walker realizes that at most he will be over» stalled for three years, since two workers are scheduled to retire at that timi- And there is the possil'iility that sales will increase sutliciently over the next three years so that all the stall would be fully utilized. lfthis did happi’ni, 01‘ course, r'ew workers would have to he hired (but no new supervisors) it the project were ir'nplemented. Walker estimates there is only a 2.0 percent chance that this would happen in any year looked at lroin a clilli:i‘eirt angle, there is an 80 percent chance in each ol‘the next three years that the two laborers used in the project Could not be producr lch'ly employed sor'rrewhere else in the firm QUESTIONS t. the accountants estimates in Exhibit 2 use the "most likely" sales lW‘itlectron in Exhibit 1 for each year. is this appropriate? Explain, 2. (a) What is the opportunity cost (sacrifice) ot' using two workers to prodiiCe the it) in and lzirrr pipe internally? (b) l'lt'iw, it at all, should the. items in Exhibit 2 be adjusted to get the incremental cash tlows of the project? Be as specific as possible tor each iteiii using tinancial theory, information priiivided in the case, and the sales projections in Exhibit lr‘ind keep in mind that yotr only want to cijinsider' those items that will change. it the project is implemented, k is) CalCltlalC the project‘s annual incremental cash llows. (The pro- ject lite is eight years and the relevant tax rate is 40 percent) 3- Wllal lime PlolC‘ct’s NPV” (Don't forget the alter~tax salvage. value oi [he ‘Xlllllmlé'nl 7 “C aPPYOpriate after tax discount rate is l3 percent) 4. Recall that WalkCt' tS unclear what the market value ol‘the equipment will be alter eight years He thinks it could be as low as $l20,000 alter taxes. llow important is this issue to the project? Be specific in terms of any impact CASE 2] VALLEY l’ORGk PLASTlCS I27 5. (a) Recall that Walker is quite skeptical otthe salesmen's estimate. of the lost orders as a result old/F’s failure to prriiduce the lOrin and t2~in. pipe internally. Is there any basis for this skepticism, <2»; peeiaily given that the salesmen are much tloser to the Situation than Wall-:er’" Detend your answer (h) Walker does think that lltAhthC [,tttitt'ltl’eth)“ ot' the 10am. and l2 in. pipe will inert'ase sales. To help him in the evaluation Walker is interested in the minimum annual increase in sales necessary to make the proieet worthwhile, What is this ligure assuming,i equal annual sales? [You may assume that ll) only material and distribution (:osts will vary with increased ['tl'UtllICthtt, (2] no ad ditional equipment is needed, (3) unit selling; price, is 56 vents per pound; (It) the, relevant altertax discount rate. is (5 pertent, and (5) the appri'ipriate tax rate is 40 percent] (e) Does it make sense to use a higher discount rate in question 5th) than in question 3"" Explain 6. Based on your prt-kvrt’rus answers and other information in the. ease, what do you reelinnmend? Fully support your answer 7. The case raises the issue ahout when, ilever, it is appropriate in the lace ot iiiStitlieieiit sales to terminate an otherwise competent ernr ployee, (a) Assume you ate the manager [but not the owner) ol‘a tirm When, it ever, is it inappropriate to do so7 You may use any ethieal and soeial arguments that you deem relevant as well as any "good business: arguments, (h) Repeat part ta) assuming that you are the owner of the Iirm EXHIBIT 1 Walker’s Estimate of the Probability Distribution of Annual Sales of lO~ln. and l2-in. Pipe, Years l-- 8 (ln Thousands ol Pounds}.' , Annual Sales Prohahility 1 1,000 le ll) k i ,200 W l moi) 50 ] 'l'lmue estimates do not (“mam [hf {\(IfislbllJy that lltz’tDUHC pigiitilrnnn may WWLVC MM “my, LJSC} UR PART IV CAPITAL BUIL‘GFTINQ EXHIBIT 2 Auounlanl's Eglimate of Annual C051 01 Produmng lOdn‘ and Win. 1 1pc InrHouse 1 Raw ynammla FEES/LON) ? HISH’lbution [051 24,000 3 Dual Iubnr 40,000 4. lndn‘wl lahm @000 5 Pension and wvHaw 6,720 6 PaymH Ian's 4,900 " UHHIIt’S 8,000 b Rupaua and nmnlcnanm 7900 0 8pm 0 (3,143!) N) (Jermgrgizl lat’lm’y 18,000 1 i Dcplflmnun 75,000 ll! LOSI inlcu’si 78,000 $(Wbo, ] 2f) Unn m5»! 5‘) 0 (Gulf, 7 hcujztl/IJOOXWU [in summon t l the :1an Hum 1 12 (Ema pm pnund um: : l .2 Ime'I pound: pm ycar J' 2' (6'11? (n pound mm 5 1 '2 Inn‘non pounds per ycar .,‘ 'IWU WHlkCIS. a! SZ'NXK) pu year cm h 4 All) mucle n! Hcm 2: Th|s15umxniylhc pnqui'as’halt (7fsupervxsurvsalaru's f‘ M pr n’rjnt Hf Hch 3 flux 4 Tina 111(Iudc5 1hr firm 5 Lunlnhuuon to in (ginplojy-yt‘g pt “51”” [mM‘ plus N-allh and dlsalnlny Insurumr h 10 pcm n! ()1 )Il‘ms 3 pluK 4 Thu Ismnuxly [0| 50Lml5t‘on1nmnduntmplmynwm unsumntr' 1 Hm plexus, {hart nf cltflmuv, MEL wale Hr :- Maxnlcnamr and rt’pmr on [M mmpnxcm ') 'IHC pnmcd's shan: (7! HM; lat, Kory Sp}1((‘ 0((Uplfd by lhc rqmpmcm and lhc Iwu WOHLI r- 10 Hm gunned}; STU!“ 0! Hcm: Ilkr ympcuy (axes, corporalc (6‘65, gm mam) gume m 11 gazed on [ht (05! of nm rquxpnmm SLUOOUO/B 17 Infl mlmml on l‘xc $60<)_(10(:u§:u1 [u putthasc' HIE (umpmrn) 13 ‘x SEOUUUO whr‘n' 13 .3 m:- pnqn 1's EHH tax (hmnunl Iiilf‘ ...
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Valley Forge Plastics - THE FIRM VALLEY FO‘iGE PLASTiCS...

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