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Bachelor of Business

Managerial Finance 367910

Semester 2, 2015
INDIVIDUAL ASSIGNMENT 2
Course Contribution:

30%. (80 Marks)

Due Date:

12PM Tuesday 19th May 2015

Hand in at:

Drop Box Level 1 WF building

Requirements:

1.

In answering the questions, marks will be awarded for:

(a)
(b)
(c)
(d)

Clarity of discussion and analysis;

Correctness of content materials;
Logical flow of the discussion involved;
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.
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

5.

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 Sebastians flare-up would intimidate his staff. In fact, they were used to his sudden
outbursts. When he was out of the office, the firms 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 Sebastians 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
2

just have to miss the managers 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 firms corporate travel
arrangements. At present, the firms 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 its 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 nononsense 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 firms 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
3

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 firms
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
Manufacturings 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 firms 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 managers 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 firms 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%
4

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 firms executives were spending in airports. Even better, the
plane would be available on a moments 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 its 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
5

from Amarillo, the executive travel managers 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 firms 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 firms 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
Sebastians 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)
Fuel
Cre
w
Maintenance
Total Direct operating
costs
Annual Fixed Cost

$2,500,00
0
1,600
7

$400
$250
$167
$817
$204,528

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

4%
6%
8%

6%
6%

3%
8%
5%
4%
3%

6. Risk Adjusted Corporate Capital Costs (after tax)

Low risk
projects
Average risk projects
High Risk Projects

7%
10%
14%

Corporate Tax Rate

40%

TABLE 2
Monkey Manufacturing Ltd
Executive Travel Forecast

- Years 5
6

10

5
0

53

56

59

62

68

71

75

79

Number of
Round Trip
Flights

65

QUESTIONS
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)

10

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 Henrys 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)
[TOTAL 80
MARKS]

11