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Capital Budgeting and Balanced Scorecard

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Problem 7: Capital Budgeting
A toy manufacturer that specializes in making fad items purchased a $80,000 molding machine
for producing a special toy three years ago. The company is considering purchasing a newer,
more efficient machine. If purchased, the new machine will be acquired today. Production and
sales of 50,000 units per year (sales of $300,000) will be the same regardless of whether the
company uses the old or new machine.

The company has two options: (1) continue to operate the old machine or (2) sell the old
machine and purchase the new machine. The following information has been assembled to
help management decide which option is more desirable.

Old machine New machine

Initial purchase cost of machine $80,000 $100,000

Estimated salvage value at the end of
useful life for depreciation purposes $0 $10,000

Useful life from date of acquisition 8 years 5 years

Expected annual cash operating costs:
Variable cost per unit $3.80 $2.50
Total fixed costs $43,200 $28,800

Depreciation method used for
tax purposes Straight-line Sum-of-years'-digits

Estimated cash disposal value of
Today $55,000 $100,000
Five years later $2,600 $7,200

The company is subject to a 40% income tax rate and requires an after-tax return of at least
10% on an investment.

Use the Net Present Value (NPV) analysis to determine if the company should keep the old
machine or replace it with the newer one. Also, consider some qualitative factors that might be
important in making your decision. Please show all your work with appropriate calculations to
support your decision.
Problem 8: Balanced Scorecard

Lee Corporation manufactures various types of color laser printers in a highly automated facility
with high fixed costs. The market for laser printers is competitive. The various color laser
printers on the market are comparable in terms of features and price. Lee believes that satisfying
customers with products of high quality at low costs is a key to achieving its target profitability.
For 2010, Lee plans to achieve higher quality and lower costs by improving yields and reducing
defects in its manufacturing operations. Lee will train workers and encourage and empower
them to take the necessary actions. Currently, a significant amount of Lee's capacity is used to
produce products that are defective and cannot be sold. Lee expects that higher yields will
reduce the capacity that Lee needs to manufacture products. Lee does not anticipate that
improving manufacturing will automatically lead to lower costs because Lee has high fixed costs.
To reduce fixed costs per unit, Lee could lay off employees and sell equipment, or it could use
the capacity to produce and sell more of its current products or improved models of its current

Lee's balanced scorecard (initiative omitted) for the just-completed fiscal year 2010 follows:
Objectives Measures Target Performance Actual Performance
Financial Perspective
Increase shareholder
value Operating-income
changes from
improvements $1,000,000 $400,000

changes from growth $1,500,000 $600,000

Customer Perspective
Increase market share Market share in color
laser printers 5% 4.6%

Internal Business
Process Perspective
manufacturing quality First time yield 82% 85%

Reduce delivery time
to customers Order-delivery time 25 days 22 days
Learning and Growth
Develop process skills Percentage of
employees trained in
process and quality
management 90% 95%


1. Was Lee successful in implementing its strategy in 2010? Explain.

2. Is Lee's balanced scorecard useful in helping the company understand why it did not reach its
target market share in 2010? If it is, explain why. If it is not, explain what other measures you might want to add under the customer perspective and why.

3. Would you have included some measure of employee satisfaction in the learning and grow
perspective and new product development in the internal business process perspective? That is,
do you think employee satisfaction and development of new products are critical for Lee to
implement its strategy? Why or why not? Explain briefly.

4. What problems, if any, do you see in Lee improving quality and significantly downsizing to
eliminate unused capacity?

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Solution Preview

See the attachments.

Problem 1:
Old Machine
Year 0 Year 1 Year 2 Year 3 Year 4
Sales $ 300,000 $ 300,000 $ 300,000 $ 300,000 $ 300,000
Initial purchase cost $ - $ - $ - $ - $ -
Running cost of machine $ (43,200) $ (43,200) $ (43,200) $ (43,200) $ (43,200)
variable cost $ (190,000) $ (190,000) $ (190,000) $ (190,000) $ (190,000)
Cash disposal value $ 2,600
Tax $ (22,720) $ (22,720) $ (22,720) $ (22,720) $ (23,760)
cash inflow $ 44,080 $ 44,080 $ 44,080 $ 44,080 $ 45,640
NPV = $168,066.52

New Machine
Year 0 Year 1 Year 2 Year 3 Year 4
Sales $ 300,000 $ 300,000 $ 300,000 $ 300,000 $ 300,000
Initial purchase cost $ (100,000)
Running cost of machine $ (28,800) $ 28,800 $ 28,800 $ 28,800 $ 28,800
variable cost $ (125,000) $ (125,000) $ (125,000) $ (125,000) $ (125,000)
Cash disposal value $ 55,000 $ 7,200
Tax $ (28,480) $ (71,920) $ (74,320) $ (76,720) $ (82,000)
cash inflow $ 72,720 $ 131,880 $ 129,480 $ 127,080 $ ...

Solution Summary

The solution provides a problem and answer regarding capital budgeting and a balanced scorecard.