The Mexton Machines Company
Case Study
(Written as at January 2003)
The Mexton Machines Company was founded in the 1950's on an old RAF
airfield in the East Midlands of England. Originally, the company produced a
range of small machines and tools for industry, but it expanded rapidly during
the 60's and early 70's and acquired interests in industrial paint manufacture,
pre-fabricated garages and building materials. New production units were
opened in Leicestershire, Yorkshire and Bristol and the Head Office was
moved to Loughborough. However, the company fared badly during the
recession of the early 1980's. The paint manufacturing side of the business
was scaled down and prefabricated garage production ceased.
In 1996 a new management team took over and it was decided that the
company should diversify into the consumer goods market. A range of
products was developed for the DIY enthusiast including an electric drill and a
car engine tuner. These are sold through the major DIY chains and hardware
stores. To date, the products have been fairly successful, though sales are
still small when compared with more established firms in this market. They
also form only a relatively small part of the company's total turnover, as shown
below:
Sales (£m)
1998 1999 2000 2001 2002 (*)
Product Group
Industrial Machinery
32.4
24.8
36.8
33.6
34.4
Paint
14.4
13.2
12.4
11.6
10.4
Building Materials
25.2
26.0
26.8
28.8
30.0
Consumer Goods
0
1.2
2.4
3.6
4.4
(* = provisional)
© 2014 John Wiley & Sons Ltd.
www.wiley.com/college/goodwin
1
The company is now (January 2003) considering the development of
gardening tools and equipment and, as a first step, a detailed plan has been
put forward to produce an electric lawnmower (code named the L5). Market
research has suggested that consumers make their decisions in this market
on the basis of price, convenience, safety and the presence of features such
as a grass collecting box and an edge trimmer. Taking this market research
information into account, an outline design has been formulated. This includes
a processor that will precisely control the height of the blades on uneven
lawns and an electronic voice that announces when the grass collecting box is
full. Now a decision has to be made on whether the project should be
continued. The market research and development of the design has already
cost £2.5 million.
If a decision to continue is made, it is hoped that a successful prototype can
be developed by December 2003. The company's chief engineer, David
Castle, has estimated that there is a 75% chance that the December target
could be achieved and that research and development costs would amount to
about £8 million. If the target is not achieved, the company will review the
situation in January 2004. It could decide to abandon the entire project or to
allow further work on the prototype. Castle estimates that modification of an
unsuccessful prototype would cost around £6.4 million and the modifications
would take an additional year to implement. He is, however, sure that all
problems would be overcome by December 2004
The company also has to consider possible locations for the production of the
L5. The list of possible sites has now been reduced to two: Wiltham in West
Yorkshire would be a new site for the company, while an existing, but unused,
factory at Eastoak aerodrome in Leicestershire could be converted for L5
production.
The Wiltham site is an old textile mill which has been closed for two years.
The site can be purchased immediately for £6 million. It is thought, however,
that there is a 20% chance that the site will still be available in one year's time
for the same price, though it is unlikely that the site will still be available in two
© 2014 John Wiley & Sons Ltd.
www.wiley.com/college/goodwin
2
year's time. Equipping the mill, which would not commence until the prototype
had been successfully developed, would cost an additional £4 million.
Because of the age of the buildings, and the need to carry out renovation
work, it would take a year before the equipment could be installed. This
means that, if a successful prototype was developed within a year, production
could commence in January 2005. However, if the prototype development
took two years, production could not commence at Wiltham until January
2006. The site is relatively small and could only cope with production of an
estimated 50,000 lawn mowers per year. However, there are warehousing
and transportation facilities and the availability of skilled labour force locally.
The site is located 20 miles from the M1 motorway and 15 miles from the
M62.
Converting the existing site at Eastoak would involve the construction of some
new buildings. The conversion would take a year and would cost about £24
million, but a decision to go ahead with conversion would not be taken until a
successful prototype had been developed. This again means that production
would commence in January 2005 if the prototype was successfully
developed within a year. However, if the prototype took two years to develop,
production could not commence until January 2006. If the site is converted, it
is anticipated that it would have a capacity to produce 166,000 lawn mowers
per year. The site is 14 miles from the M1 motorway.
Sales of the L5 would be supported by a major advertising campaign in
newspapers and local television, especially in the first few months after its
launch. In order to estimate the sales that would result, extensive use has
been made of market research, economic and industry-wide data. To simplify
the problem, the management team has decided to estimate sales under two
different market conditions: Good, and Poor. These conditions can be
assumed to prevail through the entire life of the product. The probabilities of
these conditions prevailing are thought to depend to some extent on how
quickly the product can be launched since an early launch will give Mexton an
edge over any potential competitors. The Marketing Department has
© 2014 John Wiley & Sons Ltd.
www.wiley.com/college/goodwin
3
estimated the following probabilities:
Market Conditions Prevailing
Good
Poor
January 2005
0.7
0.3
January 2006
0.4
0.6
Month production commences
It has been decided to use a 6 year planning horizon (i.e. up to December
2008) since technological developments would probably mean that a new
model would be required for the market for later years. The tables below show
the estimated net cash flows which will occur during the years of the product's
life. These tables exclude cash flows relating to purchase or value of buildings
or installation of equipment. In arriving at these estimates, it has been
assumed that, because the Wiltham site can only cope with a relatively small
volume of production, net cash flows generated by production at this site will
be largely unaffected by market conditions.
If production is at Wiltham
Net Cash flow in product's 1st year
£16m
2nd year
£16m
3rd year
£16m
4th year
£16m *
(* if applicable)
If production is at Eastoak
Market Conditions
Good
Poor
£24m
£8m
2nd year
£24m
£8m
3rd year
£24m
£8m
4th year
£24m*
£8m
Net Cash flow in product's 1st year
(* if applicable)
© 2014 John Wiley & Sons Ltd.
www.wiley.com/college/goodwin
4
At the end of 2008 it has been estimated that the Wiltham site would have a
value of £16m, while the Eastoak factory would have a value of £32m. In the
event of the Wiltham site being disposed of without being equipped (because
of the abandonment of the project after the failure of the prototype) it can be
expected to be sold for its original price of £6m. The company's cost of capital
is estimated to be 10% .For simplicity, it can be assumed that all cash flows
occur at the end of the year. Also, the effect of factors like taxation and
development grants should be ignored.
Question 1
Apply decision analysis to the decision problem facing Mexton Machines and
advise the company on their decision problem. Clearly state any assumptions
you have made.
Question 2
Discuss in detail the strengths and limitations of your analysis in the context of
the context of the problem faced by Mexton Machines.
© 2014 John Wiley & Sons Ltd.
www.wiley.com/college/goodwin
5
Rate
Buy now; prototype OK
10%
Buy now; Prototype not OK
PV Factor
Wait a year; Prototype OK Wait a year; Prototype not ok
1
0.90909091
0.82644628
0.7513148
0.68301346
0.62092132
0.56447393
Wiltham
Year Date
0 Jan-03
1 dec-03
2 dec-04
3 dec-05
4 dec-06
5 dec-07
6 dec-08
NPV
0
0
0
0
Rate
PV Factor
prototype ok, good
prototype ok, poor
prototype not ok, good
prototype not ok, poor
1
0.90909091
0.82644628
0.7513148
0.68301346
0.62092132
0.56447393
Eastoak
Year
Date
0 Jan-03
1 dec-03
2 dec-04
3 dec-05
4 dec-06
5 dec-07
6 dec-08
NPV
0
0
0
0
Rate
Abandon
Year
Date
PV Factor
buy now, abandon
wait, abandon
1
0
1
2
3
0.90909091
0.82644628
0.7513148
0.68301346
0.62092132
0.56447393
Jan-03
dec-03
dec-04
dec-05
dec-06
dec-07
dec-08
NPV
4
5
6
0
0
Purchase answer to see full
attachment