Drizzly Industries produces and sells a special type of organic machine oil sold

Question

Drizzly Industries produces and sells a special type of organic machine oil sold by the barrel. For many years, they have sold through a Seoul-based importer by the name of Park Mechanisms. Their contract with Park Mechanisms is up for renewal and Drizzly Industries has decided to look at options. You are in charge of making a recommendation.

Option 1: Sell through Park Mechanisms. Let them handle everything. Drizzly Industries receives a net payment of $5 USD per barrel.

Option 2: License production to SohnCo Importers of Seoul, Korea, who will also manage marketing and distribution of the oil. SohnCo Importers will charge Drizzly Industries a fixed fee of $5 million USD to cover marketing costs. SohnCo will pay Drizzly Industries $15 USD per barrel of Drizzly products it sells in Asia.

Option 3: Create a new enterprise, Drizzly Asia, by building a small plant for $15 million USD. Annual fixed costs are estimated to be $30 million USD and variable costs are $60 per barrel. Sales price will be $100 USD per barrel.

USD

Explanation / Answer

We will have to consider the net profitability at different levels in order to take decision. We will be making the cash forecasts for sales level of 750,000, 850,000 and 950,000 units.

________________________

Level: 750,000 units.

Option 1 Cash Flows:

______________________

Option 2 Cash Flows:

______________________

Option 3 Cash Flows:

________________________

Level: 850,000 units.

Option 1 Cash Flows:

______________________

Option 2 Cash Flows:

______________________

Option 3 Cash Flows:

________________________

Level: 950,000 units.

Option 1 Cash Flows:

______________________

Option 2 Cash Flows:

______________________

Option 3 Cash Flows:

_______________________

Recommendation:

Option 2 is the best option as it results in the maximum net cash inflow at all the levels, when compared to the other 2 options.

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