Hawthorne has just signed a contract with Pynes to sell them 100,000 lbs of plastic strapping each month for the next 6

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Hawthorne Has Just Signed A Contract With Pynes To Sell Them 100 000 Lbs Of Plastic Strapping Each Month For The Next 6 1 (169.84 KiB) Viewed 30 times

Hawthorne has just signed a contract with Pynes to sell them 100,000 lbs of plastic strapping each month for the next 6 months. If they sell high quality strapping, they get $0.60/lb; if they sell average quality strapping, they get $0.50/lb. Pynes will buy either quality of strapping. But this project will also allow Hawthorne to develop the skills to sell strapping on the retail market once these 6 months are up. At that time, the average retail market prices will be: Retail Prices (per lb after 6 mo) Min P10 P50 P90 Max High quality $ 0.85 $ 0.90 $ 1.00 $ 1.15 $ 1.20 Avg quality $ 0.68 $ 0.70 $ 0.75 $ 0.82 $ 0.86 However, developing customers for Hawthorne's strapping after the current contract expires will require an additional salesman to be added to the company. Assume that that salesman will be paid $7000 per month during the six months of the Pynes contract, and that during that time, no additional sales will occur (business development takes time). Once the six months are up, assume that the salesman's fixed salary drops to $2000 per month, but he or she also receives a 10% commission on all sales. Assume that the salesman is successful, and that Hawthorne continues to produce 100,000 lbs of plastic strapping and sells it on the retail market each month. Assume that the salesman receives commissions on all of this strapping. There is also uncertainty around how much the polypropylene resin will cost, both during the 6 months of the Pynes contract and afterward: Cost per lb Min P10 P50 P90 Max Polypropylene resin $ 0.20 $ 0.21 $ 0.22 $ 0.24 $ 0.25 Both during the 6-month contract and afterward, Hawthorne will process the resin into strapping in 100,000 lb batches, one batch per month. As it states in the case study, each month Hawthorne can choose between one of three Processes, each with a different ability to deliver high quality strapping, depending on the characteristics of the input resin (details are in the case study). The costs associated with each of the three processes are: Process 1 P50 Min P10 P90 Max $ 0.11 $ 0.115 $ 0.13 $ 0.15 $ 0.16 $185.00 $ 190.00 $ 200.00 $ 210.00 $ 215.00 Avg. Variable cost per lb Setup cost (each month) Possible additional cleanup costs (each month) None
Process 2 Min P10 P50 P90 Max $ 0.15 $ 0.17 $ 0.18 $ 0.13 $0.135 $ 660.00 $ 675.00 $ 700.00 $ 730.00 $ 740.00 Avg. Variable cost per lb Setup cost (each month) Possible additional cleanup costs (each month) $ $ - $ 100.00 $ 225.00 $ 250.00 Process 3 Min Max P10 P50 P90 0.15 $ 0.155 $ 0.17 $ 0.19 $ $ 0.20 $1,100.00 $1,150.00 $1,200.00 $1,250.00 $1,300.00 Avg. Variable cost per lb Setup cost (each month) Possible additional cleanup costs (each month) $ $ $ 100.00 $ 225.00 $ 250.00 Each month, Hawthorne also has the option to test the batch of resin to assess the likelihood that that batch is suitable for high-quality strapping. The details of the cost and the reliability of this test are given in the case dy. If Hawthorne runs the test each month, it will receive the results in time to decide which of the three Processes to use that month. Note: In the paragraph at the bottom of the third page of the case study, it says, "However, the Process 2 and Process 3 setup costs did include an allocation of $200 per production run, which Mr. Nelson had added to recover $1,200 that was spent in experimenting with the sensing devices and controls on the two processes." You do not need to take these amounts into account; the $200 is already included in the setup costs, and the $1,200 is money that has already been spent. The Assignment You will model Hawthorne's cash flow from this portion of their business over the next 24 months (6 months of the Pynes contract and 18 months after that). For each of the uncertainties listed above, you may assume that on any given trial of the Monte Carlo simulation, the value that is (randomly) chosen applies throughout the entire time period - i.e., you may assume that these prices and costs do not vary from month to month. Note, however, that the Retail Prices will only apply to the last 18 months of the cash flow model; for the first six months, you should use the fixed prices specified in the Pynes contract. The costs, however, will apply across the entire 24-month period. Use an annual discount rate of 6%, which equals a monthly discount rate of 0.487%. Use a corporate tax rate of 21% on net earnings. Create a decision support document (in Word), describing the analysis you have performed and recommending a specific course of action to Hawthorne. Pertinent graphs and charts from the model should be included as pictures in this document, but use some judgment. Graphs that make a key point should be included; those that display data that did not affect the choice of strategy should not. Those that are in the "gray zone" should be included in an appendix. Assume that Hawthorne will choose a strategy based on mean Net Present Value. This document should include a description of each of Hawthorne's alternative strategies, as well as cumulative probability curves displaying the ranges of possible values for NPV of each strategy. Key questions to address are:
1) Should Hawthorne test the incoming batch of resin each month? 2) If they don't test, which of the three Processes should Hawthorne implement during the six months of the Pynes contract? 3) If they don't test, which of the three Processes should Hawthorne implement during the eighteen months following the Pynes contract? 4) If they do test, which of the three Processes should Hawthorne implement when the test results are positive during the six months of the Pynes contract? 5) If they do test, which of the three Processes should Hawthorne implement when the test results are negative during the six months of the Pynes contract? 6) If they do test, which of the three Processes should Hawthorne implement when the test results are positive during the eighteen months following the Pynes contract? 7) If they do test, which of the three Processes should Hawthorne implement when the test results are negative during the eighteen months following the Pynes contract? 8) For the recommended strategy, which uncertainties have the biggest impact on NPV? 9) Conduct sensitivity analyses. If a key variable or two happen to end up very high or very low, but still within the range of possible values, how might that change the recommended strategy?