Reference no: EM132617892

You, CPA, work as an analyst for Glo Inc., a publicly traded and rapidly growing cosmetic company. Glo's products retail at a popular beauty store chain across Canada. Recently, Glo has been experiencing stockouts due to overwhelming demand resulting from a social media influencer who recently commented on her love of Glo's products.

• Part of Glo's strategic plan is to capture market segments that are traditionally underserved. Glo's management believes that the market for men's care products is underserved and would be an excellent fit. Glo has already reached out to the male partner of the social media influencer, and he has agreed to be part of the branding campaign for men's products. However, this will require a significant marketing investment up front - $250,000 before the first product is even introduced to the market and $45,000 per year after that.
• Earlier this year, Glo conducted a series of focus groups. In the focus groups, the research team noticed that men like how beauty products make them feel but do not want to be seen buying them. Men also prefer to buy all their beauty products in one location, whereas women don't mind shopping in two or three stores. Finally, the men in the focus groups indicated that they want immediate results from a skin-care line, whereas women consider the care to be more of a long-term investment since products often take time to be effective.
• Glo's marginal tax rate is 20%.
• Glo has already been running at maximum capacity for several months, and is looking to expand its production facility at a cost of $4 million in order to introduce the new product line, as well as to increase production of existing offerings. Glo currently has an unsecured bank loan of $2.5 million and a before-tax interest rate of 9%. There are $6 million in common shares outstanding with an 18% cost of equity. The market value for debt and equity components is equal to the above values.
• The CEO has asked you to provide input on the following issues.
• As part of the new facility, Glo is planning to upgrade its manufacturing equipment. It has budgeted $300,000 for a new piece of equipment. Both budget and quality are important factors. Glo has two options: the Xpress300 or the D-Lux550.
• The company that manufactures the Xpress300 has been producing equipment for cosmetic manufacturing for over 30 years. Glo's existing machine is from the Xpress line, and although the production manager has been happy with it, the repair and maintenance costs have been very high and have been increasing in recent years. These costs have averaged $25,000 annually since the warranty expired.
• The Xpress300 costs $420,000 and comes with a three-year warranty. The machine would have a lifespan of 10 years and no salvage value. The tax shield on the equipment is $35,000. The training on this machine is said to be very time consuming, but the production manager is hoping that because Glo's current machine is from the same company as the Xpress300, the training time will be reduced. Training is included in the cost of purchase. The manufacturer believes that repair costs will be approximately the same as the current machinery.
• The company behind the D-Lux550 is relatively new to the cosmetic manufacturing space, and has just one reference listed on the spec sheet. However, the company does have 15 years of experience in manufacturing food and beverage machinery. A benefit of going with the D-Lux machine is that Glo could lease the equipment for $75,000 per year for a 10-year term, which would include any repairs and maintenance costs. Lease payments are due at the beginning of the year. Like the Xpress300, the D-Lux550 has a lifespan of 10 years.
• There is a one-time training cost of $20,000. Although Glo does not anticipate needing it, this equipment can produce 20% more units in a year than the Xpress300.

Question:

Problem 1: Calculate the net present values (NPVs) of the costs of both machinery options (the Xpress300 and the D-Lux550), and identify the most cost-effective alternative from a quantitative perspective. As well, prepare qualitative assessment of the Xpress300 and the D-Lux550, and make an overall recommendation for the CEO's consideration.