DDBA 8006 Week 6 Capital Request Brief Example

A Second Press or Another Year of Overtime: A Capital Request Brief for a Plastic Molding Shop, With the Amount, the Return and the One Condition in the First Paragraph

Student Name

Walden University

DDBA 8006: Contemporary Challenges in Business

Instructor Name

Month Day, Year

A Second Press or Another Year of Overtime: A Capital Request Brief for a Plastic Molding Shop, With the Amount, the Return and the One Condition in the First Paragraph

Summary

Request: approve $420,000 to buy and install a second 300-ton injection molding press at Prairie Molded Components. At the firm's 12 percent hurdle rate, the press is worth about $166,000 in present value terms over eight years and pays back in about 3.7 years. Condition: buy only if Hartley Appliance, the largest customer, signs the renewal it has offered for at least four years. If Hartley commits for three years or less, the net present value turns negative, and the shop should continue paying overtime instead.

The Decision

Prairie Molded Components, a composite contract molder of 38 people in Cedar Rapids, Iowa, makes plastic housings, brackets and knobs for appliance and equipment makers. Its one large press runs six days a week, two shifts, and the shop has paid about $95,000 a year in overtime to keep up. Hartley, which buys about 40 percent of the large press's output, has offered to renew its supply contract and asked whether Prairie can take on two new part numbers. The owner must answer before the contract expires in March.

Exhibit 1: Cash Flows

Table 1

Second Press, Base Case (dollars)

All figures composite; the hurdle rate is the owner's stated minimum return on equipment.

Why Payback Appears Beside Net Present Value

Net present value is the better measure, because it counts every year's cash and the lower worth of money received later. Brealey et al. (2020) set out the standard argument that projects with positive net present value add to a firm's value and that payback ignores cash after the cutoff. The brief reports payback anyway. Graham and Harvey (2001), surveying chief financial officers, found that payback remained widely used beside discounted measures, especially at smaller firms with owners close to the decision. Prairie's owner thinks in payback terms because the shop's bank lines are short and a press that has not paid for itself is a press the bank still worries about. Reporting both lets the owner use the familiar measure while seeing the better one.

Exhibit 2: What the Answer Leans On

The answer leans on one assumption above all: how long Hartley stays. If Hartley leaves, the overtime disappears, because the existing press can handle the remaining volume, and the new parts disappear with it. The press then earns only what other customers' work brings, about $42,000 a year before tax. The table shows the turning point between three and four years. By contrast, if overtime savings were 20 percent lower than last year's figure but Hartley stayed, value would remain positive, at about $95,000. Damodaran (2012) recommends testing a project against the input most likely to be wrong, not every input equally; here that input is the customer.

Table 2

Net Present Value by Years Hartley Stays

If Hartley leaves, overtime savings and new-part contribution end; remaining pre-tax benefit assumed at $42,000 a year from other customers' work.

Recommendation

Approve the press on the condition that Hartley signs at least a four-year renewal covering the two new parts. If Hartley offers three years, counter with a price concession in exchange for the fourth year; a modest discount costs less than the gap between three and four years of commitment. If Hartley will not commit beyond three years, decline the press and budget for overtime, revisiting the decision at the next renewal.

Outside the Brief's Scope

The brief does not value the possibility of winning new customers with the added capacity, which would raise the net present value but cannot be counted on. Nor does it consider financing; the owner intends to pay from a line of credit and retained earnings, which is a separate decision.

References

Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of corporate finance (13th ed.). McGraw-Hill Education.

Damodaran, A. (2012). Investment valuation: Tools and techniques for determining the value of any asset (3rd ed.). Wiley.

Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2-3), 187-243. https://doi.org/10.1016/S0304-405X(01)00044-7