ABC Coatings, Inc.: equipment replacement analysis.
Maheshwari, Sharad ; McLain, P. Michael
PROCESS OF POWDER COATING
The powder coating method is a process of application of a surface
layer without any solvent. In general, a free flowing powder is applied
to the surface of the product. This surface is subsequently heated so
the powder can stick to the metal (or non metal) product surface.
The process involved three major steps
1. Surface preparation
2. Powder Application
3. Heating or Thermosetting of powder coating
Surface preparation involves cleaning of the metal part surface.
The cleaning of surface is very critical for the quality of the product
as coating can only adhere to clean surfaces. Mostly, for metal part
chemical spray or chemical bath cleaning process is used. Product is
dried out completely after the cleaning.
A dry product surface is then sprayed with the powder coating. The
most metal coating use is epoxy or polyester based powder. The powder is
sprayed using an electrostatic spray gun. The electrostatic property
allows the powder to stick to the surface temporarily.
The product is then passed through or kept in an oven at an
appropriate temperature for powder to melt and to stick to the surface.
Once powder is evenly melted, the part is allowed to cool to room
temperature. Time and temperature of heating depend upon the type of
material and type of coating. (Wikipedia, 2007)
FACILITIES NEEDED
The company is planning to upgrade and to automate main processes
related to the surface coating of metal parts. That is, the process of
part cleaning, power spraying and thermosetting will be updated.
Currently, it is setup as a three-station facility. These stations are
independent of each other. The parts are moved from one station to
another station on industrial carts.
The new facility will include interconnected stations connected via
automated conveyor systems. These stations will perform cleaning,
drying, power spraying, and thermosetting in succession. The company
also owns a fleet of forklift trucks and other carts as the material
handling equipment. The new facility will not need some of these
material handling equipments at the manufacturing floor, as the company
is planning to put an automated conveyor belt system for material
handling with the shop floor. However, the fleet of forklift trucks will
still be used in the shipping and receiving area.
Like any industrial plant, ABC Coating has areas for storage of raw
material and finished goods as well as receiving and shipping areas. It
also owns the equipments needed in the receiving and shipping area.
These facilities and equipments are in good conditions and do not need
any immediate investment. Furthermore, since most of the ABC's
customers are from the automotive industry and the company is part of a
regular supply-chain with its customers. This allows the company to
carry only one week of inventory of raw material and finished goods in a
normal business cycle. Given the lower inventory levels requirements,
ABC Coatings does not see a need of increasing storage facilities in the
near future.
Similarly, the powder and chemical storage facility also will not
have any changes. The company has sufficient storage facility for the
current needs as well as the future needs for 3-5 years. In the same way
the waste handling systems, which are a main part of chemical cleaning
processes, will not need any improvement.
COST OF NEW PLANT
The cost of new equipment is listed in the Table 1 below. The new
plant upgrade relies on the computer aided tools to support the
operations. The ABC Coating, Inc. does not have any significant computer
expertise. Therefore, the new plant will require IT training as well as
at continual annual support for the IT infrastructure from the vendor of
the system.
WORKFORCE
The change in the plant will change the workforce as well. The
plant will move from more manual and partly mechanized machines to
largely computer controlled tools and equipment. Tables 2 and 3 provide
the current and proposed workforce structure. The Tables 2 and 3 also
provide the salary rates of old and new workers. The workforce
requirement will change in the new plant as company will require less
workers and supervisors. Currently, the total workforce is 33 workers.
In the new plant, less than 50% of the current workforces will be
needed. However, new plant will add a new category of worker called
system operator. This IT worker is not needed in the old plant.
Typically, an hourly-wage worker works 2,000 hours per year. The company
has not incurred any significant overtime cost in the past few years.
INFORMATION TECHNOLOGY AND OPERATIONAL COST
The new plant will rely on MPR software to carry out most of the
plant scheduling and control functions. The functioning of the system
will be critical for the proposed plant. The company will have to buy
service agreement with the software vendor after installation That is,
the software company only priced in the cost of the product and
installation. The service plan is not included in the system
installation cost. The service agreements cost varies from $25,000 per
year for full support to $8,000 per year for minimal technical support.
This company has lower IT skill set hence would be buying the full
service agreement after installation of the system.
Direct materials cost is expected to remain constant with the
introduction of the automated assembly system. There may be some slight
improvements based upon better operations, but these savings is hard to
estimate at this time. It is expected that there would be an increase in
electric usage of the new system. The increased in the monthly expense
is expected to be about $1,500 a month.
The proposed plant will have lower payroll cost as it will need
only 16 employee as opposed to 33 in the current system. The company
estimates benefit cost as a percentage to the total employee payments.
The benefit cost rates of the hourly workers and yearly employees are
30% and 40% respectively.
The equipment will be depreciated over a ten-year useful life. The
equipment will have no salvage value. The corporate tax rate is 35%. The
company's cost of capital is 8%. Also, assume that old plant is
fully paid and depreciated at this time.
OTHER COSTS DISCUSSION
The firm currently spends $50,000 per year on the cleanup of minor
chemical spills in the manufacturing process. The introduction of the
new equipment should reduce the cost to $10,000 per year. Besides
cleanups of minor spills, there is a small probability of a major
chemical spill. Pressure from the firm's liability insurer and a
threat of potential governmental actions concerning cleanup after a
major spill are encouraging the company to look into the potential cost
of a major spill. Besides most major clients also wants company to
maintain high environmental management system's (EMS) standards.
The cost of government mandated cleanup after a major spill may also
come with substantial penalties, which the company would like to avoid.
The new plant and equipment are good for reducing the chance of a major
spill. There is only a one percent probability that a major spill would
occur within the current system. If the new equipment is installed, the
probability of a major spill would decline to one-tenth of a percent.
After a review with the insurance company, ABC Coatings has learned that
a major spill could cost approximately $10,000,000.00.
The new equipment would provide up to 25% increase in production
capacities. At present, the company is operating at 80-85% capacity. The
management is not necessarily optimistic that it can increase sales at
this point beyond current rate of 2-5%. The company can hold on to the
current market share if it can control its production cost. The cost
reduction is becoming increasingly important due to cheaper foreign
competitors. In other words, the management is simply considering the
new plant to reduce the production cost not because of potential of
higher production capacity. Therefore, any increase in sales is ignored
in the current calculations. The company would remain viable for the
next ten years. To solve its dilemma of whether to upgrade or not, the
company has also provided the last two years of its income statements
and balance sheets. The income statements and balance sheets are
included in the Tables 4 and 5. Also inflation considerations are
ignored at this time.
CASE QUESTIONS
1. Should ABC Coating Company acquire the new machines and
modernize its plant?
2. Prepare a schedule of the current system and the cost of the
proposed system.
REFERENCES
McLain, P.M., Sharma, J.K., & Stretcher, R. (2003.) Beach
Foods, Inc. Journal of the International Academy for Case Studies. 9(1).
Wikipedia (2007.) Powder Coating. Retrevievd January 12, 2007. Web
Site: http://en.wikipedia.org/wiki/Powder_coating.
Sharad Maheshwari, Hampton University
P. Michael McLain, Hampton University
Table 1: Estimated Cost of New Equipment and IT Installation
Item Cost
Two semi-automated conveyor drive integrated systems $1,000,000.00
for powder coating $500,000.00 each
Automated conveyor belt systems to connect receiving $600,000.00
and shipping areas
Installation of new systems $500,000.00
Computer control systems (turnkey) (System cost $500,000
includes HW and small business MRP software)
Training $250,000
Total $2,850,000
Table 2: Current Workforce Classification and Salary Rates
Type Number Salary or Hourly Rate
Pallet Movers 5 $10.00/hour
Machine Operators 12 $15.00/hour
Line Workers 10 $16.00/hour
Supervisors 3 $85,000 per year
Schedulers 3 $45,000 per year
Total 33
Table 3: Proposed Workforce Classification and Salary Rates
Type Number Salary or Hourly Rate
Pallet Movers 2 $10.00/hour
Machine Operators 5 $15.00/hour
Line Workers 5 $16.00/hour
Supervisors 2 $85,000 per year
Schedulers 1 $45,000 per year
System Operator 1 $75,000 per year
Total 16
Table 4: Income Statement of ABC Coatings, Inc. for 2006 and 2007
(McLain, et al. 2003).
Item 2007 2006
Net Sales $10,315,881 $9,474,409
Cost of Goods $8,489,024 $7,757,539
Gross Margin $1,826,857 $1,716,870
Operating Expenses $1,613,035 $1,587,097
Other income/expenses $17,042 $4,743
Income Before Taxes $230,864 $134,516
Income Taxes $62,333 $36,319
Net Income $168,531 $98,197
Extraordinary Item $0 $0
Net Income after Extra $168,531 $98,197
Preferred Dividends $0 $0
Net Income for Common $168,531 $98,197
Table 5: Balance Sheet of ABC Coatings, Inc. for 2006 and 2007.
Items 2007 2006
Assets
Cash $95,089 $41,488
Marketable Securities $0 $0
Accounts Receivable $544,809 $463,894
Allowance $0 $0
Net Receivables $544,809 $463,894
Inventories: (Finished, WIP, Material/ $442,588 $480,950
Supply)
Other Current Assets $0 $9,189
Total Current Assets $1,082,486 $995,521
Investments $0 $0
Trademarks & other Assets $23,826 $19,581
Total Property (Land, Building, Machine, $1,453,611 $1,292,417
etc.)
Accumulated Depreciation $876,784 $770,988
Net Property Plant & Equipment $576,827 $521,429
Intangible Assets $0 $0
Total Assets $1,683,139 $1,536,531
Liabilities
Notes Payable $148,832 $119,489
Accounts Payable $824,447 $674,936
Accrued Liabilities $0 $0
Payroll & Employee Benefits $12,298 $16,560
Advertising $0 $0
Other Taxes $0 $0
Income Taxes $13,223 $10,582
Other $0 $0
Total Accrued Liabilities $25,521 $27,142
Current Maturities on Long-term Debt $0 $0
Total Current Liabilities $998,800 $821,567
Long Term Debt $185,084 $238,133
Deferred Income Taxes $0 $0
Other Liabilities $0 $0
Minority Interests in Subsidiaries $0 $0
Owners Equity
Stockholders Equity $499,255 $476,831
Total Liabilities and Stockholders Equity $1,683,139 $1,536,531
