Carded Graphics, Llc Sheeter Replacement Decision (Solution)

5526 words 23 pages
UVA-F-1606TN
Rev. Sept. 1, 2011

CARDED GRAPHICS, LLC: SHEETER REPLACEMENT DECISION Teaching Note

Synopsis and Objectives The owner of a midsize folding carton printer is considering the replacement of an old machine for cutting sheets of paper from rolls (a sheeter) with a new one. This standard capital budgeting analysis, which requires identification of both the relevant cash flows and the relevant discount rate, is enhanced by an alternative that is not explicitly stated but can be readily identified and analyzed—to outsource all sheeting and close down the sheeting operation. This alternative, which turns out to be financially optimal based on quantifiable case facts, forces students to consider strategic and other nonquantifiable
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2. Describe the economic factors that drive this decision. The goal of this discussion is to identify the core economic drivers of the decision: the lower cost of roll paper relative to sheeted paper and the improved efficiency and capacity of the new machine. A careful discussion will also identify an embedded outsourcing decision—even if the internal sheeting operation is run efficiently, is it economically preferable to outsourcing the whole process. This last alternative will surprise most students as will the eventual analysis of that choice. 3. What is the appropriate discount rate? More-experienced students will immediately identify a cost of capital based on firms in the industry. Some discussion could focus on the essential drivers of risk and justify alternatives. The less-sophisticated students will attempt to calculate a cost of capital for Carded Graphics (difficult and questionable given its extremely high leverage) and might even suggest using the marginal borrowing rate since that is how the acquisition will be financed (a theoretically flawed argument). 4. What are the cash flows associated with keeping the old equipment and with replacing the old equipment? What are the resulting present values? Most students will recognize that calculating the present value of both cost structures and

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