AirTractors Incorporated design, manufacture and build custom hauling vehicles

QUESTION

AirTractors
Inc.

AirTractors
Incorporated design, manufacture and build custom hauling vehicles. The company was founded in Waycross Georgia in
the early 1960s as a parts subcontractor to the farm implement industry. Early in their business history AirTractor
Inc. had parts contracts with John Deere, Minneapolis Moline, Fordson and
International Harvester in addition to local specialized farm implement
manufactures and dealers. AirTractor was
solely dependent on the farm economy during its early stages of the companys
development. When the agricultural
business boomed, the company did well.
However, when the other side of the cycle hit, the company suffered. Looking for a way to stabilize the dependent
and cyclical nature of the company, the owner Darryl Owen decided to seek some
non-agricultural dependent contracts.

Darryl
was visiting his brother-in-law Phil who lived in Atlanta in the early spring
of 1965 when the idea of specialized luggage tractors was suggested to
him. Phil was a pilot for Delta Airlines
at the time and was complaining how inefficient the baggage handling had become
at the new Hartsfield Airport in Atlanta.
The baggage carts were pulled by hand out to the planes and back, and
the ground crew in charge of the baggage sometimes had to pull baggage carts
that were in excess of a ton. This was a
tough enough job when the weather was good; however it caused real delays when
there was rain or the occasional snow squall hit the Atlanta region. Darryl suggested to his brother-in-law that
they should design a special vehicle to tow the baggage carts to their destinations,
thus AirTractors was born.

The
first prototype came off the assembly line in the spring of 1966 and was tested
at Hartsfield in Atlanta. Darryl ran the
plant and Phil kept his job as a pilot.
However, Phil would also œdrop-in on airport managers as he flew around
the country, extolling the virtues of their new product. With in two years, Phil became the head of
sales for AirTractors Inc. as they built first a nation wide, and then a
world-wide following.

Today,
the luggage tractors are built in a specific sequence, starting with a solid
frame. It is very important to have
precise fit in the frame and the engine mounts due to the extreme weights and
pressures that the tractors must endure.
There are tests at every step of the process and if the components do
not pass them, the tractors must be disassembled and rebuilt. Depending where in the production process the
failure takes place in, this could cost the company anywhere from $500 to $15,000. During the last inspection the tractor is
tested on a dynometer to ensure that the tractor can endure both the stress and
torque required to perform up to standards.
Finally the tractor is cleaned, cradled and crated for shipping.

Presently the AirTractors Inc. is a publicly traded corporation,
which has a work force of 213 full-time employees in the plant. The head office has 17 full-time staff. Its products include the six models of
airport towing tractors, a line of luggage carts (they attach behind the
tractors for hauling) and a line high torque aircraft movers (larger towing
tractors), used for repositioning aircraft around the airports or at their
gates. The high torque aircraft movers
will fit any commercial airplane manufactured.
There are also adapter forks, which will fit almost any foreign aircraft
manufactured airplane, so that the products can be used overseas.

The business has grown substantially since its beginnings. The
company now encompasses three distinct divisions broken down on their product
lines. The projected sales for each of the product lines for the upcoming year
are as follows: towing tractors – $14,425,000,
luggage carts – $3,800,000, and aircraft movers – $3,200,000.

In April 2006 there was a serious discussion at the board meeting
that the plant needed a new lathe for wheel spindle components. The existing lathe had been used in spindle production
for 12 years and the tooling tolerances were getting harder to maintain. Jerry Jones, the company comptroller,
suggested that a new machine be purchased as soon as possible.

Jerry had been in Atlanta, Georgia the previous week and had
inquired into the cost of a new machine at Southern Tools Incorporated. The new machine had a purchase price of $700,000. The seller required a $25,000 down
payment. At the end of its useful life
the machine would have a cash value of $50,000.
This is $30,000 more than its book value at that time. If AirTractors Inc. does not want to purchase
the lathe; Hydraulics Incorporated will lease the machine to AirTractors for
$140,000 per year for 6 years.
Jerry returned from Atlanta and went straight to the companys
local bank. Rachael Willson, the local
bank manager who handled the AirTractor account, informed Jerry that the bank’s
policies stated that she could approve a six year loan for the new lathe. The rate on the new loan would be 8%.

Jerry inquired as to the high rate on the loan. Janet assured him that this was going rate
for commercial loans, and with AirTractors Inc. 30% tax rate the loan rate was
not as high as it sounded.

Cash Projection Problems
Phil Kolbe, the companys credit manager for the towing tractor
division, had noticed a disturbing trend in the payment pattern of AirTractors
Inc.’s customers. Five years ago the
customers had a payment pattern of 40% paying cash, 45% paying in the first
month after the purchase and 15% paying in the second month after the purchase. The pattern of payment has changed he noted
in a recent discussion with Walter Wood.
He had told Walter that the current payment pattern was 30% paying cash,
40% paying in the first month after the purchase and the remainder paying in
the second month after the purchase. The
firm is considering giving a 2/10 net 30 discount to speed up collections.

The projected and actual monthly sales for the towing tractor in the
upcoming budget period are:

Actual Sales This Year:
Month Sales
November
480,000
December
540,000

Projected Sales: Next
year
January
$1,750,000
February 1,200,000
March
2,200,000
April 1,700,000
May
1,500,000
June 1,250,000
July 850,000
August 1,350,000
September
1,300,000
October 1,475,000
November 1,375,000
December
1,575,000
Total
17,252,000

The expenses for the period take the following pattern. The engines are ordered and paid for two
month prior to the month in which the sale occurs. The engines costs are 10% of the projected sales
for that month. Wheels and tires, which
are also outsourced, are ordered and paid for one month prior to the month in
which the sale occurs. The costs of the
wheels are 5% of the projected sales for that month. The company has variable costs of production
of 20% which occur and are expensed in the month of the sale.

The company has a fixed cost of $150,000 per month, pays salaries
of $420,000 per month and has wages equal to 20% of that months sales. The company has a $275,000 tax payment due on
a quarterly basis (due March, June, September and December). Also, the company
incurs miscellaneous expenses of 10% of the sale in the month of the sale.

Inventory
The variability in sales has consequently led to problems in
inventory. Stan Brown has studied the
sales and has concluded that the use of EOQ to order inventory could be
employed on a limited basis, for example, small components.

As an example, Stan noted that AirTractor Inc. used 28,000 wheels
of the same size during the previous year.
The wheels were ordered from Standard Pneumatic (SP) in Jacksonville, Fl.
about 320 miles away. SP can get an
order to AirTractor Inc. in 6 days, and in half that time if it is a rush order. (Note:
all orders rush, or not, must be given in multiples of 25). The tires cost $22.00 each. Inventory holding costs are estimated to be
10% and the order costs are $75.00 per order.

According to Stan most other inventory items are not conducive to
EOQ. As an example, Stan used tractor
engines. Below are the months and the
number of engines that will be used to meet the firms projected sales. There is a two months delay between the order
and the final sale. In other words, the
engines ordered in November will be in tractors sold in January.

Months
Engines Used
November 180
December 650
January 1,950
February 3,110
March 3,900
April 2,490
May 2,205
June 908
July 375
August 375
September 220
October 190
Total 16,553

The engines are ordered from OMC in Michigan. OMC can get an order ready for AirTractor
Inc. in 3 weeks, 2 weeks if it is a rush order.
The engines cost $435.00 each.
The inventory holding costs are approximately 12% and the order costs
are $2000 per order. The reason that the
order costs are so high is because AirTractor Inc. is responsible for
picking-up the order in Michigan. Stan,
however, is wondering if he could cut the costs of carrying inventory by
ordering engines every 2 months rather than monthly.

Cash Mash
AirTractor Inc. projects that cash outlays of $6 million dollars
will occur uniformly throughout the year next year. The company plans to meet its cash
requirements by periodically selling marketable securities from its
portfolio. The firms marketable securities
earn 9% and the cost per transaction of converting securities to cash is $42.00. The standard deviation (σ2) of the cash is $75,000 and the company
has to maintain a minimum cash balance of $100,000 in their checking account
according to their bank agreements.
Questions

1) a) Using the Baumol Model of cash management
please calculate the amount of cash that should be transferred?
b) Graph the
results.

2) a)
Using the Miller “ Orr model calculate the Z*, the ideal amount (z) and the Upper
Limit (h) for the company (in nearest 1000s).The company wants to keep the
lower level (r) at $100,000.
b) Graph the
results.
3) Given the sales estimations and the cost
estimates, do a complete cash budget for the first 6 months of next year. (Total
revenues, total expenses and monthly cash balance from that months
transaction).
4)
What is the economic value ordering quantity?
5)
How many orders should be placed each year?
6)
What is the reorder should point?
7)
Calculate the total inventory cost
8)
What is the total cost of ordering and carrying inventories, including safety
stock.

ANSWER

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