Contented Milk Cows, INC. (Fictional)

CONTENTED MILK COWS, INC. (FICTIONAL)

Contented Milk Cows, Inc. (CMC) is a national distributor of dairy farm equipment with the past year’s sales revenue approaching $30 million. Their present product lines include about 75 products including milk cans, milking machines, milking stall equipment, cleaning supplies, etc. In addition to the small corporate offices, CMC has regional sales and service offices that cover most milk producing areas in the U.S. Dairy farming, like most industries has evolved over the years. Originally, most farmers had 1-10 milk cows that provided their family farm with milk and cream, and the remainder was sold to a local dairy to provide money for groceries and other family expenses. Cows were herded into small milk barns twice a day where stanchions closed around the cows head to hold them steady while the farmer sat and milked each cow. Farms gradually became more specialized with herds of 50-100 milk cows, and eventually up to several hundred in some cases. With this, milking machines became standard that were attached to each cow manually after the cows were herded into stanchions. Improvements were made like using rotating stanchions to lessen the required preparation and removal time, but it still required extensive manual attention. Automation has now become available with robotic machines replacing the manual part of herding cows into the barn and milking stalls, fitting the milking machine to the cow, feeding, herding cows out of their stall, etc. With this automation, dairy farmers look at computer monitors as often as their cows. The references below provide information on robotic milking systems. This thirteen minute marketing video offers a good overview of the entire system: http://www.youtube.com/watch?v=GkMgwlR4vRc Andrew, the sales manager of CMC, recently visited the World Dairy Expo in Madison, Wisconsin and met a producer of a robotic milking system from a foreign country that is looking for a distributor to sell their product line in the United States. When he returned home, Andrew broached CMC’s top management with this opportunity and they asked him to prepare a financial proposal to assist them in making a decision whether to take on this product line. Strategically, this would be a major change in their business. It is emphasized that this is an internal proposal for CMC to consider whether to adopt this as a major addition to their product lines; not for a sales brochure to assist dairy farmers in making a decision on buying one. CMCs existing product lines are milking hardware with products requiring minimal installation and maintenance. This new product line will require knowledge and skills involving electronics and computers; a substantial change from the existing product lines. The proposed product will require additional storage and showroom space and additional service people. Extensive training by staff at all levels of the organization from the CEO though sales and installation/service employees will be needed. It is expected that the existing sales staff is sufficient to handle the sales aspect of this new product since there will be diminished sales for the existing product lines. The cannibalization effect on the existing products line is to be ignored in this proposal.

CENTRAL WAREHOUSE A new corporate warehouse will be needed to receive shipments form the foreign manufacturer and service the regional offices. The central warehouse will store all the modular components that compose a robotic milking system. Designs for systems will be received from sales people and a shipment with all the required hardware will be assembled and shipped directly to customers where CMC staff will assemble it. The central warehouse is estimated to cost $350,000 to construct and furnish. The warehouse will be built on CMC owned land that has been appraised at $125,000 (opportunity cost). The warehouse should be depreciated using 20-year MACRS and is expected to have a salvage value of $550,000 at the end of 10 years. Since land is not depreciable, its book value at the end of year 10 is still the original year 0 appraisal, and the estimated land value at the end of year 10 is $150,000. (The MARCS 20-year depreciation percentages can be found at the end of the data block.) Annual maintenance and operating cost of the warehouse, including heating and air conditioning, are estimated at $30,000 in year 0 and a constant $96,000 annually for years 1-10. The central warehouse initially (year 0) will be stocked with $200,000 of inventory. In year 1 and following years, inventory in all locations (central and regional) is expected to be 25% of sales. Regional locations will be stocked with inventory starting in year 1. Three new hires will be needed in the central office for product design, repair consultation, and internal training. The plan is to add one person in year 1 at an annual cost of $125,000 annually for wages and benefits. In year 3, a second employee will be added at $100,000 annually. In year 5, the third employee will be added at $75,000 annually. Wages payable is not to be included in working capital.

REGIONAL OFFICES The 20 regional offices are leased and additional space for a demonstration capability, repair part storage, and a repair area is needed. In some cases the present regional offices can be expanded and in others, new office space will need to be rented with associated moving expenses. This upfront renovation expense is forecast to average $25,000 per regional office and this will not be depreciated and will have no value at the end of year 10. Therefore, it is a year 0 expense on the income statement and not an investment. The added regional annual office expense for each regional location for maintenance, heating, and cooling is estimated at a constant $12,000 annually starting in year 1. Each regional office will need to hire a service technician that is estimated at $84,000 annually each (for all 10 years) starting in year 1. This is an annual expense since it is not dependent on sales volume.

TRAINING UPFRONT Upfront design, sales and repair training will be extensive. Training programs will have to be designed, training facilities rented, and training sessions held. The total of these is estimated at $350,000 in year 0.

YEAR 0 EXPENSES Note that there are year 0 (up front) expenses for inventory, training, central warehouse expense, and regional office renovations that are not depreciable, nor do these expenses have a salvage value. Simply list them in the income and cash flow statement where applicable as would be done if they were in years 1-10. These will be in addition to the year 0 central warehouse investments.

REVENUE AND COSTS The annual sales quantities of the robotic milking systems is expected to be 10 systems in year 1, 20 in year 2, 305 in year 3, and 40 in years 4 through 10. Each system will be sold at an average price of $290,000. This includes a 10 year warranty for parts and labor. Cost of the product purchased from the foreign manufacturer that includes shipping will be 60% of the revenue. Additional costs to assemble, ship and install each order at customer farms is estimated at 7.5% of revenue.

WORKING CAPITAL The foreign manufacturer offers payment terms of “Net 60” meaning that CMC has 60 days to pay and therefore accounts payable will be two months of purchase cost (2/12% percent of purchases). The accounts payable will start in year 0 as inventory is purchased in year 0. CMC customers will be granted payment terms of “2/10 net 30” meaning they have 30 days to pay with a 2% discount if paid in 10 days. For this proposal, accounts receivable can be considered as one month of sales (1/12% of sales revenue) starting in year 1. Inventory is discussed above in the Central Warehouse section. Assume all working capital to be zero at the end of year 10 since it could feasibly be liquidated if operations were ceased then.

ANDREW’S CHARGE Andrew has been charged to do the following: 1. Provide a ten year present worth financial analysis to determine if this proposal is financially advisable. He is to use a minimally acceptable rate of return of 10%, income tax rate of 20%, and a capital gains tax rate of 15%. 2. Summarize the financial resources that will be needed to fund this (how they will be obtained is not to be addressed).. 3. Cite potential risks and what potential financial effects could these have? 4. Summarize any non-financial considerations that need to be considered when making an accept-reject decision.

REFERENCES Grobart, S. "The $210,000 Cow-Milking Robot", Bloombery Business Week, October 12, 2012. http://www.businessweek.com/articles/2012-10-05/the-210-000-cow-milking-robot McKinley, J. "With Farm Robotics, the Cows Decide When It's Milking Time", New York Times, April 22, 2014 http://www.nytimes.com/2014/04/23/nyregion/with-farm-robotics-the- cows-decide-when-its-milking-time.html Sjostrom, L., Producers share insight on milking cows with robots", Hoard's Dairyman, September 2, 2014. http://www.hoards.com/blog_milking-cows-with-robots Szondy, D., "Lely Astronaut A4 milking robot lets cows milk themselves", gizmag, Deptember 2, 2013 http://www.gizmag.com/lely-astronaut-a4/28901/ Weisman, S. "Roboting Milking", American Dairymen, September.http://www.americandairymen.com/articles/robotic-milking