Introduction
Any business should strive for continuous development and empowerment, especially in competitive markets. Pursuing innovation and recognizing the importance of organizational transformation allows companies to remain resilient and resistant to the external environment of the industry market. This paper examines the case of Shoals Corporation, which was faced with a choice.
Case Background
Shoals Corporation uses backhoes in its organizational practices, which are quite complex machines that require continuous maintenance. On the one hand, the company can keep and overhaul its existing backhoes. On the other hand, Shoals Corporation can purchase five new machines to replace its existing machines. Each decision has risks and benefits, but the final verdict must be made based on the financial analysis performed. The work seeks to use several economic tools to evaluate the effectiveness of each of the two decisions.
Initial Investment Comparison
Comparing the investments required for each solution is an integral part of the individual analysis and the subsequent tests. Specifically, if the company were to keep its existing backhoes, it would incur an investment cost of $55,000.
In contrast, if the company decides to replace the old machines with new ones, the salvage value would be defined as the purchase cost of the new backhoes ($200,000) minus the present value of the old ones ($42,000), which is $158,000. In comparison, the initial investment for new machines is almost three times higher, which means it is more financially advantageous and less costly to overhaul existing backhoes.
Net Present Value
In financial analysis, net present value (NPV) is used to compare two or more projects in terms of benefits. NPVs greater than zero respond to a favorable decision to invest in such projects (Fernando, 2022). However, when comparing two NPVs, from a financial point of view, the one with the higher value is more profitable: this means that the investment is more profitable because it generates more cash flows than the costs of the investment. In other words, the higher the NPV, the better because the investment will create more value for the company.
Figure 1 shows the results of calculating NPVs for two projects, namely, keeping the old machines or buying new ones, for each year over eight years. The final PVs are also calculated, and the final NPVs are determined by considering the initial investment defined in the last section.
As can be seen from the results, the NPV for the first project (keeping the existing backhoes) is about 1.3 times higher than purchasing new machines. Given the nature of NPV, the first option is preferable for Shoals Corporation. This, in turn, is the second confirmation of the argument that the company should undertake a major overhaul rather than an acquisition.
Payback Periods
Payback period analyses also provide helpful information about each project to help you make an informed decision. The payback period (PP) is a measure of the time it takes for an investment to recover its initial costs. In other words, during this time, the project will fully equalize with the initial investment and thus will pay off.
Figure 2 shows the results of calculating PPs for two projects: As one can see, the first one takes about half the time (1.8 years) compared to acquiring new machines (3.6 years). This means that the first project is more profitable in the context of time consumption and will start generating profits faster. Hence, this is the third proof for the argument in favor of older backhoes.
Intangible Advantages
When it was clear that there was more evidence in favor of using refurbished older machines, it was necessary to discuss further the intangible advantages or disadvantages of such a decision. Shoals Corporation’s main intangible asset is the employee operators who operate and maintain the backhoes. When acquiring new machines, additional time and finances must be invested in training them, which, although it may take up a small number of resources, is still required. In contrast, using refurbished older backhoes does not require this expense.
On the other hand, upgrading machinery is a viable strategy in the face of technological advances, and to keep up with the growth rate of potential competitors, Shoals Corporation might consider spending more to purchase new backhoes. However, this is a more difficult decision because it requires an analysis of technological capabilities, potential performance improvements of the new machines, and justification of the possible difference given the high financial cost.
Conclusion
To summarize, all financial tools have shown that a project to upgrade older backhoes is more profitable and cost-effective in both a financial and time context. This is solid evidence that Shoals Corporation should overhaul existing machines rather than choose to invest in new ones. Nevertheless, one must consider the pace of technological advancement and the potential possibility that in a few years, the old backhoes will be obsolete and unable to provide good performance compared to the competition.
Reference
Fernando, J. (2022). Net present value (NPV): What it means and steps to calculate it. Investopedia. Web.