The Mexton Machines Company Case Study

Part 2: The Mexton Machines Company Case Study
(Written as at January 2017)
The Mexton Machines Company was founded in the 1950’s in the East Midlands
of England. Originally, the company produced a range of small machines and
tools for industry, but it expanded rapidly during the 60’s and early 70’s and
acquired interests in industrial paint manufacture, pre-fabricated garages and
building materials. New production units were opened in Leicestershire,
Yorkshire and Bristol and the Head Office was moved to Loughborough.
However, the company fared badly during the recession of the early 1980’s. The
paint manufacturing side of the business was scaled down and prefabricated
garage production ceased.
In 1996 a new management team took over and it was decided that the company
should diversify into the consumer goods market. A range of products was
developed for the Do-It-Yourself (DIY) enthusiast including an electric drill and a
car engine tuner. These are sold through the major DIY chains and hardware
stores. To date, the products have been fairly successful, though sales are still
small when compared with more established firms in this market. They also form
only a relatively small part of the company’s total turnover, as shown below:
Sales (£m)

Product Group
Industrial Machinery
32.4 24.8 36.8 33.6 34.4
2012 2013 2014 2015 2016 (*)
Paint 14.4 13.2 12.4 11.6 10.4
Building Materials 25.2 26.0 26.8 28.8 30.0
Consumer Goods 0 1.2 2.4 3.6 4.4
(* = provisional)

The company is now (January 2017) considering the development of
gardening tools and equipment and, as a first step, a detailed plan has
been put forward to produce an electric lawnmower (code named the L5).
Market research has suggested that consumers make their decisions in
this market on the basis of price, convenience, safety and the presence
of features such as a grass collecting box and an edge trimmer. Taking
this market research information into account, an outline design has been
formulated. This includes a processor that will precisely control the height
of the blades on uneven lawns and an electronic voice that announces
when the grass collecting box is full. Now a decision has to be made on
whether the project should be continued. The market research and
development of the design has already cost £2.5 million.

If a decision to continue is made, it is hoped that a successful prototype can be
developed by December 2017. The company’s chief engineer, David Castle, has
estimated that there is a 75% chance that the December target could be
achieved and that research and development costs would amount to about £8
million. If the target is not achieved, the company will review the situation in
January 2018. It could decide to abandon the entire project or to allow further
work on the prototype. David Castle estimates that modification of an
unsuccessful prototype would cost around £6.4 million and the modifications
would take an additional year to implement. He is, however, sure that all
problems would be overcome by December 2018
The company also has to consider possible locations for the production of the L5.
The list of possible sites has now been reduced to two: Wiltham in West Yorkshire
would be a new site for the company, while an existing, but unused, factory at
Eastoak aerodrome in Leicestershire could be converted for L5 production.
The Wiltham site is an old textile mill which has been closed for two years. The
site can be purchased immediately for £6 million. It is thought, however, that
there is a 20% chance that the site will still be available in one year’s time for the
same price, though it is unlikely that the site will still be available in two year’s
time. Equipping the mill, which would not commence until the prototype had been
successfully developed, would cost an additional £4 million. Because of the age
of the buildings, and the need to carry out renovation work, it would take a year
before the equipment could be installed. This means that, if a successful
prototype was developed within a year, production could commence in January
2019. However, if the prototype development took two years, production could
not commence at Wiltham until January 2020. The site is relatively small and
could only cope with production of an estimated 50,000 lawn mowers per year.
However, there are warehousing and transportation facilities and the availability
of skilled labour force locally. The site is located 20 miles from the M1 motorway
and 15 miles from the M62 motorway.
Converting the existing site at Eastoak would involve the construction of some
new buildings. The conversion would take a year and would cost about £24
million, but a decision to go ahead with conversion would not be taken until a
successful prototype had been developed. This again means that production
would commence in January 2019 if the prototype was successfully developed
within a year. However, if the prototype took two years to develop, production
could not commence until January 2020. If the site is converted, it is anticipated
that it would have a capacity to produce 166,000 lawn mowers per year. The site
is 14 miles from the M1 motorway.
Sales of the L5 would be supported by a major advertising campaign, especially
in the first few months after its launch. In order to estimate the sales that would
result, extensive use has been made of market research, economic and industrywide data. To simplify the problem, the management team has decided to
estimate sales under two different market conditions: Good, and Poor. These
conditions can be assumed to prevail through the entire life of the product. The
probabilities of these conditions prevailing are thought to depend to some extent
on how quickly the product can be launched since an early launch will give
Mexton an edge over any potential competitors. The Marketing Department has
estimated the following probabilities:

Month production commences
January 2019
0.7 0.3
Market Conditions Prevailing
January 2020 0.4 0.6

It has been decided to use a 6 year planning horizon (i.e. up to December 2022)
since technological developments would probably mean that a new model would
be required for the market for later years. The tables below show the estimated
net cash flows which will occur during the years of the product’s life. These tables
exclude cash flows relating to purchase or value of buildings or installation of
equipment. In arriving at these estimates, it has been assumed that, because the
Wiltham site can only cope with a relatively small volume of production, net cash
flows generated by production at this site will be largely unaffected by market

If production is at Wiltham
Net Cash flow in product’s 1st year
2nd year £16m
3rd year £16m
4th year £16m *

(* if applicable)
If production is at Eastoak
Market Conditions
Good Poor

Net Cash flow in product’s 1st year £24m £8m
2nd year £24m £8m
3rd year £24m £8m
4th year £24m* £8m

(* if applicable)
At the end of 2022 it has been estimated that the Wiltham site would have a
value of £16m, while the Eastoak factory would have a value of £32m. In the
event of the Wiltham site being disposed of without being equipped (because
of the abandonment of the project after the failure of the prototype) it can be
expected to be sold for its original price of £6m. The company’s cost of capital
is estimated to be 10%. For simplicity, it can be assumed that all cash flows
occur at the end of the year. Also, the effect of factors like taxation and
development grants should be ignored.
Question 1
Apply decision tree analysis to model the decision problem facing Mexton
Machines and advise the company on the policy or strategy that maximizes
expected Net Present Value (NPV). Clearly state any assumptions you have
Guidance notes:
Present your decision tree diagrams, clearly showing all probabilities and
net present values at the end of the branches
Follow the conventions of constructing decision trees, such as the basic
shapes distinguishing decision nodes from chance nodes
Clearly show all your workings explain/justify your recommendations
Question 2
Conduct a sensitivity analysis on your model and explain the implications to
the Mexton Machines decision problem.
Guidance notes:
Justify your selection of input variable(s) used as the basis of your sensitivity
Clearly show and explain the impact of your selected variables, with the aid
of graphical representations
Question 3
Discuss the strengths and limitations of your analysis in the context of the the
problem faced by Mexton Machines. In other words, outline the strengths and
limitations of your decision tree analysis in terms of the usefulness of the
guidance that it would provide to Mexton Machines managers.

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