A division of Valles Global Industries (VGI) produces and sells a special type o

Question

A division of Valles Global Industries (VGI) produces and sells a special type of organic machine oil sold by the ounce. For many years, they have sold in Asia through a Seoul-based importer by the name of Park Enterprises. Their contract with Park Enterprises is up for renewal and VGI has decided to look at options. You are in charge of making a recommendation.

Option 1: Continue to sell through Park Enterprises. Let them handle everything. VGI receives a net payment of $5 USD per ounce.

Option 2: Sell a license for production to SohnCo Importers of Seoul, Korea. They will also manage marketing and distribution of the oil. SohnCo Importers will charge VGI a fixed fee of $2 million USD per year to cover marketing costs. SohnCo will pay VGI $10 USD per ounce of VGI products it sells in Asia.

Option 3: Create a new enterprise, VGI Asia, by building a small plant for $10 million USD. Annual fixed costs are estimated to be $1.5 million USD and variable costs are $0.60 per ounce. Gross revenue per ounce is $30.

USD—United States Dollar

Develop a five-year forecast for each of the three options. Assume there is no inflation and do a pre-tax analysis. Develop a cash flow forecast assuming sales remain variable at somewhere between 700,000 ounces and 950,000 ounces. Make and support a recommendation as to which of the options to employ.

Explanation / Answer

Let assume sales is 800,000 ounces.

Option 1: Sell through Park Enterprises:

There is a net cash inflow of $4,000,000 every year for the next five year.

Option 2: Sell a license for production to SohnCo Importers of Seoul, Korea:

Net cash inflow every year for the next five year = (800,000 x $10) - $2,000,000 = $6,000,000

Option 3: Create a new enterprise, VGI Asia:

Decision/Recommendation:

Option C is the best option as it has the maximum of profit amongs all of the options.

Year Cash Flow Variable cost Fixed Cost Net Cash Flow 0 -10,000,000 -10,000,000 1-5 (Each Year) 24,000,000 480,000 1,500,000 22,020,000

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