The business manager of Tolkien Transport wishes to analyse three strategic options available to the company (Cost-cutting; Diversification; Expansion) under four possible UK macroeconomic conditions: Recession, Low Growth, Medium Growth and High Growth. He has summarised available information in the following pay-off matrix (with impact on company profits in the next year in £000s).
|Recession||Low Growth||Medium Growth||High Growth|
Assume that the income statement for Tolkien Transport last month is as follows:
|Revenue (500 customers*£2000)||£1,000,000|
|Less variable expenses||£410,000|
Note: The revenue given is calculated by multiplying number of customers last month (500) by £2,000 the average price for transportation services
Tolkien Transport is planning a refurbishment of its depot in Leeds, which will involve investment in new garage and repair facilities to speed servicing of vehicles. After initial screening, two alternative designs have been identified (labelled here A and B) and you are asked to undertake an investment appraisal of the two identified options, which are mutually exclusive. The assumption is that they both have an eight-year life and that there is some salvage value at the end of Year 8; for Option A this is £40,000 and Option B, £30,000. The initial outlay (in Year 0) required for each option varies and they will yield different levels of cash flows over their eight-year lives which arises from the labour and time savings from using the new facilities. Tolkien Transport wishes to use an 8% discount rate for Option A, but a 10% discount rate for Option B which uses an innovative design that is considered riskier. For Option A, there will be a need for further investment in Year 5 to update equipment; this is not the case for Option B. The net annual cash flows (in £000s) of the two options under consideration are as follows:
|Year 0||Year 1||Year 2||Year 3||Year 4||Year 5||Year 6||Year 7||Year 8|
A year or so ago Tom Tolkien invested in Drive Equip Plc, a new electric vehicle equipment company, which at the time had just been listed on the UK’s Alternative Investment Market (AIM). After extensive research and development Drive Equip has just introduced an innovative navigation system which identifies the availability of electric vehicle charging points. The main distribution channel for the new product will be sales through specialist vehicle equipment distributors. However, the firm is also considering distributing the system using direct marketing.
The distribution and promotional costs differ, so the profitability of the product varies with the method selected. Using specialist vehicle distributors, the profit contribution per unit amounts to £120; if the company uses direct marketing the profit contribution rises to £160 per unit. In addition, the company’s estimate of the advertising costs and sales time per unit sold will also vary with different distribution channels. The relevant information is summarised in the table, below.
|Specialist Distributor||Direct Marketing|
|Advertising cost per unit||£24||£36|
|Sales time per unit sold||5 hours||6 hours|
Drive Equip management has specified that at least 1100 units must be distributed through direct marketing during the first three months. The company has set its advertising budget at £96,000 and has stated that a maximum of 24,000 hours of sales time will be available for the three-month planning period. In addition, production capacity for this period is 3000 units.
[Excel Sensitivity Report and Present Value Table are on the next page]
Present Value of £1
|Present Value of £1|
|(after n years)|
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