MSc
Financial ManagementFoundations of
Finance 2009
Coursework
Submission Deadline: 9th December 2009, 3pm
(We recommend you not to submit in the last minute as the past student experience has shown that doing so could be extremely risky. Target
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Word limit: 2,500 words.
HARDING PLASTIC MOLDING COMPANY
CAPITAL BUDGETING: RANKING PROBLEMS
On January 11, 1993, the finance committee of Harding Plastic Molding Company (HPMC) met to consider 8 capital-budgeting projects. Present at the meeting were Robert L. Harding, president and founder, Susan Jorgensen, comptroller, and Chris Woelk, head of research and development. Over the past 5 years, this committee met every month to consider and make final judgment on all proposed capital outlays brought up for review during the period.
Harding Plastic Molding Company was founded in 1965 by Robert L. Harding to produce plastic parts 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 made strong efforts to diversify in an attempt to avoid the cyclical problems faced by the auto industry. By 1993, this diversification attempt led HPMC into the production of over 1,000 different items, including kitchen utensils, camera housings, and phonographic and recording equipment. It also led to an increase in sales of 800% during the 1975–1993 period. As this dramatic increase in sales was paralleled by a corresponding increase in production volume, HPMC was forced, in late 1991, to expand production facilities. This plant and equipment expansion involved capital expenditures of approximately $10.5 million and resulted in an increase of production capacity of about 40%. Because of this increased production capacity, HPMC made a concerted effort to attract new business and consequently recently entered into contracts with a large toy firm and a major discount department store chain. While non-auto-related business has grown significantly, it still represents only 32% of HPMC’s overall business. Thus, HPMC has continued to solicit non-automotive business, and, as a result of this effort and its internal research and development, the firm has four sets of mutually exclusive projects to consider at this month’s finance committee meeting.
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Over the past 10 years, HPMC’s capital-budgeting approach evolved into a somewhat elaborate procedure in which new proposals are categorized into three areas: profit, research and development, and safety. Projects falling into the profit or research and development areas are evaluated using present value techniques, assuming a 10 percent opportunity rate; those falling into the safety classification are evaluated in a more subjective framework. Although research and development projects have to receive favorable results from the present value criteria, there is also a total dollar limit assigned to projects of this category, typically running about $750,000 per year. This limitation was imposed by Harding primarily because of the limited availability of quality researchers in the plastics industry. Harding felt that if more funds than this were allocated, “we simply couldn’t find the manpower to administer them properly.” The benefits derived from safety projects, on the other hand, are not in terms of cash flows; hence, present value methods are
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