Tuesday, July 21, 2015

Monkey Manufacturing Case Study

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Bachelor of Business

Managerial Finance 367910

Semester 2, 2015


Course Contribution:                      30%. (80 Marks)

            Due Date:                                                    12PM Tuesday  19th May 2015
Hand in at:                                          Drop Box Level 1 WF building

1.         In answering the questions, marks will be awarded for:

            (a)        Clarity of discussion and analysis;
            (b)        Correctness of content materials;
            (c)        Logical flow of the discussion involved;
            (d)   Quality of communication, e.g. correct spelling, grammar and sentence structure, proper page numbers and correct referencing used.

  2.       All assignments should be headed with a bar-coded signed cover sheet which you can download from arion. Instructions on retrieving the cover sheet is on AUT Online

  3.       This assignment must not be done in teams which involve sharing of information. Students are required to work independently.

  4.       This assignment must be fully typed, one sided with double-line spacing using 12 font Arial.  Any references and quotations taken from other authors must be properly acknowledged.
  5.       A hard copy of the assignment is to be handed in at the drop box on level 1 of the WF building. A soft copy will also need to be submitted to Turn-it-in by 12PM, 19th May 2015

Monkey Manufacturing Ltd

Sebastian Henry was well known for his bad temper. He was screaming at his general sales manager, screaming at his executive assistant, and screaming into the telephone at his manager of executive travel. As founder, president and CEO at Monkey Manufacturing Ltd, a $60 million dollar sporting goods retailer with sales outlets located in 42 states, you might think that Sebastian’s flare-up would intimidate his staff. In fact, they were used to his sudden outbursts. When he was out of the office, the firm’s headquarters staff quietly jokes that you could tell when Sebastian was getting ready to blow by watching his ears. Whenever his blood pressure started to rise, the tips of Sebastian’s ears would turn bright red and begin to twitch, and the angrier he became the more they would twitch. Yes, Sebastian was a hyperactive kind of guy, and Monkey Manufacturing was a high-stressed place to work.

As Sebastian slammed down the telephone, none of the corporate officers needed to check his ears since it was quite obvious he was furious. Here he was, he complained loudly to anyone within earshot, sitting at corporate headquarters at Amarillo, Texas when he needed to be in Peoria, Illinois in just three hours for the regional sales meeting. The executive travel manager had just informed him that this was physically impossible because the next scheduled flight to Peoria would not leave Amarillo until 9.00 the next morning. He would just have to miss the manager’s meeting at the Peoria store – unless he chartered a private jet out of Amarillo. Unfortunately private jets were hard to come by in Amarillo with little more than three hours notice.

As Sebastian started to calm down, he started to realise that it might be a good time for Monkey Manufacturing to consider a permanent change in the firm’s corporate travel arrangements. At present, the firm’s steadfast travel policy required all executives to fly economy on scheduled commercial airline flights – no chartered jets, no first class upgrades. By 1996, the firm had grown to include retail locations in modestly populated states like Iowa, Wyoming, Utah and Arkansas. Trying to reach the far-flung corners of the corporate empire using commercial airlines had become a logistical nightmare, and Monkey Manufacturing’ executives were wasting far too much time sitting in airports waiting for connecting flights to their final destinations.

While Sebastian had an excitable personality, he was also a fairly astute business manager. He realised that corporate jets were quite expensive, and until recently, Monkey Manufacturing had been unable to justify such an extravagant purchase. On days when the plane sat parked at the airport, the firm would have to pay it’s full time flight crew anyway. When the chief pilot got sick or the plane went into the shop for maintenance, managers would have to resort to commercial airline flights. Even worst, Sebastian knew that the no-nonsense institutional investors who owned a large block of Monkey Manufacturing common equity would take a dim view of pampered managers flying in corporate luxury at their expense.

Still he realised that it was vital for the headquarters staff to communicate regularly with retail managers in the field, and more often than not, the best way to communicate was a face-to-face meeting. To accomplish these site visits, Sebastian and his senior management staff were spending an increasing amount of time in the air. Table 1 provides a summary of the current travel statistics at Monkey Manufacturing showing that executives made 48 round trip flights from Amarillo headquarters during the year. Even with careful effort to reduce executive travel, airline usage at Monkey Manufacturing was growing by 5% each year. Table 2 summarises the firm’s expected travel plans in each year of the next 10 years.

Upon further investigation, Sebastian was able to assemble all of the travel costs and pricing data shown in table 1. At this point he was sincerely interested in establishing a new corporate travel policy for the coming decade at Monkey Manufacturing. The change would be difficult however because the various options confronting him were somewhat technical and not directly comparable to one another. Moreover Sebastian was concerned that the company had just spent $250,000 in the previous fiscal year to revamp the way the firm managed executive travel, adding expensive computer hardware and a proprietary software scheduling system to help coordinate the busy executive travel schedule at the firm. Changing the corporate travel policy at this juncture would most likely make the firms recent investment obsolete.

In spite of this potential loss, Sebastian felt it was time for a change. The software management system was simply not able to keep up with the frantic schedule of the firm’s executives, and the headquarter team needed to spend more time in the field. After reviewing his options, Sebastian identified three alternative courses of action he would consider:

  1. Contract Flight Times on Commercial Carriers

This option would require the smallest change to Monkey Manufacturing’s current travel policy. Executives would continue to fly economy on scheduled commercial flights, but under a series of annually renewable contracts with a major domestic airline, Monkey Manufacturing average ticket price would be $1,000, and first class upgrades would be available for an additional $300 per ticket. The frequent flier discount shown in table 1 could be used to reduce both of these fares, however ticket prices were subject to annual price increases under the terms of the contract.

Even worse, Monkey Manufacturing would be required by the airline holding the contract to book reservations at least three business days in advance of the intended departure date, and the firm’s executive would be required to make all connecting flight arrangements through the same carrier. The final limitation meant that Monkey Manufacturing travelling executives could look forward to an average delay of around four hours per round trip flight as they awaited connecting flights in airport terminals. In addition the form would need to continue staffing the executive travel manager’s position to coordinate executive travel arrangements. Given these drawbacks and the cost uncertainty associated with annual ticket price increases, Sebastian viewed this option as the most risky solution to the firm’s travel problems.

2.      Private Aircraft Purchase

As the second alternative, Monkey Manufacturing could purchase a new Cessna Citation II corporate jet for $2.5 million. With a range of 1600 nautical miles on a full tank of gas, the corporate jet could reach each of the retail stores without the need for intermediate refuelling. The plane could have a 10 year useful life at Monkey Manufacturing and would be depreciated on a straight line basis over an 8 year period toward a 20% salvage value. At the end of its 10 year service life, Sebastian was assured that the plane would easily bring a price of $325,000 in the used aircraft market.

Unfortunately, jet ownership would require Monkey Manufacturing to bare the cost of hiring a flight crew and maintaining the airplane. Table 1 details the fixed and variable operating cost estimates as well as the forecasted annual price increases associated with these costs. There were a few advantages provided by this option, however. By purchasing the plane now Monkey Manufacturing would avoid any price increases associated with the rising price of jet aircraft over the next decade. In addition a corporate jet would eliminate practically all of the dead time that the firm’s executives were spending in airports. Even better, the plane would be available on a moment’s notice so Sebastian could get from Amarillo to Peoria with little advance planning. Finally Monkey Manufacturing would no longer need an executive travel manager to coordinate and manage executive travel plans. The more Sebastian considered this possibility, the better it looked. He rated it the lowest risk alternative of the three options.

3.      Corporate Aircraft Time Sharing

A third and final option offered an intriguing possibility for Monkey Manufacturing. For just $630,000 the firm could acquire a 25% ownership interest an a Citation II from Jet Share Inc., a Fort Worth firm providing corporate clients with timeshared use of jet aircraft. Monkey Manufacturing would share ownership of the jet with other firms, and company executives could have exclusive use of the plane for flights anywhere in the continental United States with just two hours advance notice. Monkey Manufacturing would be charged $1060 per hour of flight time for direct operating expenses and the firm faced fixed costs of $134,580 in each year of the time share contract. Each of these costs would remain constant for the duration of the time-share contract.

The good news was that Monkey Manufacturing could depreciate its ownership share of the plane on a straight line basis over the five year term of the time share contract toward a 20% salvage value. At the end of the contract, Jet Share would repurchase the plane at it’s book value, and establish a new 5 year time share contract using a new plane. In addition, with only two hours advance notice required for departures from Amarillo, the executive travel manager’s position at Monkey Manufacturing could be eliminated. The bad news was that the replacement time share contract would carry prevailing market prices and Monkey Manufacturing would bare the risk of price increases for new aircraft as well aircraft operating expenditures, after just five short years. According to Jet Shares promotional literature, customers could expect these price increases to average about 4% each year.

Given the novelty of the time-share contract and the fact that jet share did not have much of a track record, Sebastian was a little hesitant to endorse this option. At the same time, this plan required virtually no connecting flights and offered greater price protection than the contract arrangement with a commercial airline. All things considered, Sebastian rated the risk level of this option higher than the aircraft purchase option but lower than the contract option with a commercial carrier.

With all the facts on the table, it was time to get them organised and make a decision. Monkey Manufacturing had enjoyed 5 years of steadily rising sales and profits, yet the firm’s managers were not comfortable making multi-million dollar capital acquisitions at the drop of a hat. In addition, Sebastian was worried that a corporate jet might be viewed by outside directors and shareholders as an unnecessary extravagance. Most certainly travel by private jet would provide first class accommodations for the firm’s management team and the corporate travel policy had always required the austerity of economy flights even for Sebastian. Finally, Sebastian realised that he could ill afford to disappoint the board with an inappropriate capital expenditure. Just last month they gently and firmly admonished him to treat his employees with greater respect and control his temper. The Board was clearly satisfied with the sales and profit growth Monkey Manufacturing enjoyed under Sebastian’s leadership, but privately many board members were beginning to express reservations that the financial end did not necessarily justify the management means. As Sebastian retired to his office to consider his options, he realised he needed to make a decision – but more important he needed to make the right decision.   

4. Jet Aircraft ownership costs (Cessna Citation II)

Acquisition cost


Range (nautical miles)


Passenger seating capacity (excluding crew)


Direct operating cost summary (per hour of flight)







Total Direct operating costs


Annual Fixed Cost


5. Projected Annual Price Increase for Travel Related Expenditure (%)

A: Salaries

Travel Office personnel


Flight Crew


Executive Travelers


B. Commercial Air Fares

Economy tickets


First class tickets


C: Capital Expenditures

Jet Aircraft Prices


Fuel Costs


Maintenance Costs


Fixed Expenses


Capital Cost


6. Risk Adjusted Corporate Capital Costs (after tax)

Low risk projects


Average risk projects


High Risk Projects


Corporate Tax Rate



Monkey Manufacturing Ltd

Executive Travel Forecast

 - Years -


Number of

Round Trip



1.       Given that each of the three corporate transportation alternatives covers a different length of time, what time period should be used to compare these options?                                                                                                                                                                 (2 Marks)

2.      In constructing the cash flows associated with each option, how should the analyst treat Monkey Manufacturing $250,000 expenditure for computer hardware and software to coordinate its executive travel schedule? Why?                    (2 Marks)

3.      In constructing the cash flows associated with the commercial airline contract option, should the analyst include: (a) the average cost of economy tickets; (b) the cost of upgrading an economy fare to a first class ticket; and/or (c) both of these ticket prices? Be sure to explain your answer, and indicate how each of these costs would appear in the capital budgeting analysis.                                                                                   (4 Marks)

4.      In constructing the cash flows associated with the commercial airline contract option, should the analyst include the lost time that Monkey Manufacturing travelling executives spend waiting for connecting fights in airport terminals? If so, how should this time be represented in each year of the capital budgeting analysis?(6 Marks)

5.      What is the annual depreciation expense that Monkey Manufacturing may claim against taxable income under each of the three travel options?                                (6 Marks)

6.      Does each of the three travel options contain a different risk level? If so, how should the analyst incorporate the risk differential within the capital budgeting analysis? Be sure to identify the appropriate discount rate necessary to evaluate each alternative in answer, and explain your selection of each particular discount rate.         (6 Marks)

7.      Should the capital budgeting analysis include the forecast inflation rates shown in Table 1? If so, demonstrate how each of these inflation factors will affect the various cash flows in the capital budgeting analysis.                                                                    (8 Marks)

8.      What is the net salvage value that Monkey Manufacturing can expect to receive from (a) the aircraft purchase option, and (b) the aircraft time share option?(4 Marks)

9.      Based on your answer to question 1 through 8, prepare a schedule of corporate cash flows relevant to each of the three travel alternatives, and calculate the present value of the total cost of each option. In developing the cash flows, assume that capital expenditures necessary to fund a change in Monkey Manufacturing travel policy occur in the current period (Year 0) and all operating expenditure begins in the next fiscal year (Year 1).                                                                                                                 (18 Marks)

10.   In question 9, should the analyst focus on before tax or after tax cash flows? Why?                                                                                                                                            (2 Marks)

11.    The case describes that Monkey Manufacturing has enjoyed several years of growing profitability. How does this information influence your answer to question 10? If the case included information that led you to believe that Monkey Manufacturing would suffer several years of financial losses over the next decade, how would this new information change your estimates of project cash flows expected from each of the three travel alternatives ?                                                                                      (3 Marks)

12.   In evaluating capital budgeting projects with different project lives, financial analysis often use a technique called the Equivalent Annual Annuity. Would this technique be useful in this case to evaluate the three travel alternatives? Why or why not?                                                                                                                                                                     (4 Marks)

13.   Is Sebastian Henry’s assessment of the risk level of each travel alternative sufficient justification for the financial analysis to apply different discount rates to each of the three travel alternatives? Why or why not?                                                         (9 Marks)

14.   All things considered, which of the three should Sebastian select? Be sure to justify your answer on the basis of (a) your capital budgeting analysis of the three travel alternatives, and (b) the contextual information provided by the case.             (6 Marks)        


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