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(Answered) Road King Truck

GJS File: Road King Trucks Rev 2.doc Last Revised: 4/30/2010 ASSESSMENT INSTRUMENT BUS 500D Road King Trucks Introduction Michael Livingston has recently been hired as the CEO of Road King Trucks, Inc. Previously he had been the marketing manager for a large manufacturing company and had established a reputation fo r identifying new consumer trends. Road King Trucks Inc. is a California-based truck manufacturi ng company. The company is well known for manufacturing large, heavy-dut y trucks at a reas onable cost. One of its greatest achievements is that its trucks can be eas ily modified or customized for different applications. Road King Truc ks also builds school buses. The company is considering an expansion of its current product line to include transit buses. Mr. Livingston feels th at due to high gasoline prices, commuters will be more willing to consider using mass transit instead of using their cars to commute to work. Company Profile Road King Trucks, Inc. was established by th e Smith brothers in 1880 as the California Wagon Company. The firm started manufactu ring horse-drawn wa gons to serve the growing population in California. The brothe rs quickly realized that the times were changing, so they started looking for the t echnologies that would keep them at the forefront of their field of business. In 1915, the Smith brothers decided that they needed to make trucks as replacements for the wagons, because trucks were starting to serve the same uses as wagons, and the wagon industry wa s not going to be vi able in the longer term. The company started making school buses in the early 1940?s. Most manufacturers had been commissioned by the government to produ ce different large vehicles to support World War II operations. Road King Trucks opt ed to produce buses. It was an easy decision to make, since the buses would us e common parts with the company?s trucks, and the customers were local governments. Starting in the 1950?s, the school bus business accounted for about 50% of Road King Trucks? revenues. The Transit Bus Opportunity Mr. Livingston arranged a meeting with the fi rm?s top management, as well as the chief design and manufacturing engineers to pr opose his new product. He presented an argument that more individuals in the United States and Canada would be willing to use public transportation than before, because pe ople were becoming more environmentally conscious. Also, recent increases in fuel cost s seemed to be long lasting. This was an opportunity to get people hooked on transit buses, as he put it. The proposal under consideration was for the in troduction of a large, public transport bus. To distinguish Road King Trucks from other manufacturers, the proposal included details about the level of comfort, air-conditioning, efficiency, and quietness of operation that needed to be developed. GJS File: Road King Trucks Rev 2.doc Last Revised: 4/30/2010 Mr. Phillips and Mr. Lopez, the two engineer s, reacted enthusiastically and quickly pointed out that the bus coul d be based on the company?s tr ucks. The frame currently used for building the trucks could be modifi ed to accommodate buses at a relatively low cost. The marketing vice president, Mr. Chen, pointed out that a marketing analysis could be done quickly, and at a reasonable cost. At this point, Mr. Livingston charged the participants in the meeting to produce a financial plan for the development and production of a transit bus. Public Transportation The use of public transporta tion had declined steadily si nce the 1950?s. Most people were opting to use their persona l vehicles for all of their tr ansportation needs. Recently, however, most of the metropolitan areas in the United State and Canada, the target markets for the new bus, had become more and more congested;and parking, which was already very expensive, was becoming scarce. This combination of trends has renewed the public?s interest in good and reliable public transportation. Several municipalities have been campaigning to their residents and commuters that they should use public tr ansportation for business commuting, and only use their cars for shopping and w eekend activities. However, such campaigns need to be supported by making high quality public transp ortation available to the target riders. The Decision Three weeks after the in itial meeting, the vice presidents presented the sales and cost forecasts shown in the attached exhibits. The information presented contains the cost of production, financing informati on, and warranty cost estimates. The proposals also contained two engine options for the engines: The Detroit engine, and the Marcus engine. The Detroit engine was more expensive to in stall, but had a lower warranty cost. The Marcus engine was less expensive to install, but had a higher warranty cost. This begged the question: Which engine should be used? Issues and Analyses Mr. Livingston noticed that there was a grea t deal of enthusiasm among the management group about the transit bus opportunity, but his cautious nature told him to also seek a more objective viewpoint. Consequently, he sought out you to analyze the proposed project and provide your recommendations direc tly to him. The issues he wants you to address in your analysis and report are the following: 1) How much importance should be gi ven to the energy cost situation? 2) What are the project?s cash flows for th e next twenty years? What assumptions did you use? 3) What is the company?s cost of capital? What is the appropriate discount factor (which may be different) for you to use in evaluating the bus project? 4) If you decide to go ahead with the project, which of the two engines should be used in the bus, and why? 5) Evaluate the quality of the project, by using appropriate capital budgeting techniques. GJS File: Road King Trucks Rev 2.doc Last Revised: 4/30/2010 6) Would you recommend that Road King Truc ks accept or reject the project? What are the key factors on which you base your recommendation? Your final report is due in Blackboard on Thursday December 15 @ 3:00 PM., also please bring a hard copy of you r paper to class on December 15. GJS File: Road King Trucks Rev 2.doc Last Revised: 4/30/2010 Exhibit 1: Sale s and Cost Forecast The sales forecast is based on projected levels of demand. All the numbers are expressed in today?s dollars. The forecasted average inflation per year is 3.5%. Price per bus $220,000 Units sold per year 11,000 Labor cost per bus $50,000 Components & Parts $95,000 Selling General & Administrative $250,000,000 NOTE: Average warranty cost per year pe r bus for the first five years is $1,000. The present value of this cost will be used as a cost figure for each bus. Afterwards, the bus operator will become responsib le the repairs on the buses. The buses can be produced for twenty years. Afterwards, the desi gns become obsolete. Engine choices Engine Detroit engines Marcus engines Price per engine, incl uding installation $20,000 $18,000 Average annual warranty cost per year for five years. Afterwards, the bus operator will become responsible for the repairs on the buses.* $1,000 $1,500 The chosen engine will be installed in every bus and will become a cost figure for each bus. NOTE: The engine manufacturers are not providing Road King Trucks with any warranty. However, Road King Trucks will pr ovide a warranty to its customers. After the initial five years, the bus operators ma y purchase an extende d warranty from any insurance company that offers such packages. GJS File: Road King Trucks Rev 2.doc Last Revised: 4/30/2010 Exhibit 2: Investment Needs To implement the project, the firm has to inve st funds as shown in the following table: Year 0 Year 1 Year 2 Year 3 $400 million* plus the land the company owns** $500 million* $200 million* $100 million Production and selling of buses starts * Road King Trucks estimated that it would co st a total of $1 billio n to build the factory and purchase the necessary equipment to produce the buses. The other $200 million investment, divided equally in years 2 and 3, is for non-depreci able labor training costs. Such investment is treated as
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