Capital Budgeting Methods and Cash Flow Estimation
Tasty Foods Corporation (Part A)
November 5, 2012
Executive Summary: Tasty Foods has seen phenomenal growth throughout its lifetime in large part due to a continuous development of innovative new products. Although prosperous for Tasty Foods from its birth, this is a business initiative that in the past years, Tasty Foods has not maintained. Consumers are shifting towards a more health conscious lifestyle and until now Tasty Foods has not presented any new products to capture this segment of the market. Abigail developed a product called High Energy to target the health conscious and athletic consumer without taking into account the high fat content per serving. To amend this oversight, the idea for High Energy-Lite was born. High Energy-Lite rides on the strengths of High Energy while also being able to overcome its weakness, the 5 grams of fat per 8 ounce serving. The results of a test marketing program undertaken by Tasty Foods showed that the lite version of High Energy would be widely accepted and it is Abigail’s belief that High Energy would receive a larger market share if it were offered in a lite version. As the hired consulting firm, it was our job to determine whether undertaking the development of High Energy Lite would in fact be as profitable a project as Abigail believed.
Through careful analysis of different factors, our consulting firm has concluded that this project should be undertaken. We have taken important aspects of introducing a new product such as cannibalization as well as lease costs and inflation rates to determine the profitability of this project. The profitability of this project, coupled with the enthusiastic acceptance of the test marketing program carried out earlier this year, will allow Tasty Foods to strengthen its position in the marketplace by entering into the “athletically inclined and health conscious” demographic. We believe this is a great opportunity and strongly endorse this project and thus propose that High Energy Lite enter production. This product has a great return on investment and will position Tasty Foods to expand its grasp on Lite products enabling the development of a line of Lite Frozen Pizzas. Contained in this case study are several scenarios, all profitable.
In our analysis, we placed most importance on Net Present Value (NPV) to show how this project will contribute to your wealth(I think the the word wealth sounds awkward). We also used Internal Rate of Return (IRR) and Modified Rate of Return (MIRR) to estimate the project’s rate of return. Profitability Index (PI) was also included in evaluating this project, to show the relative profitability of High Energy-Lite. The higher these measures, the more value this project is adding to the company. A few things to keep in mind while reviewing our analysis and referring to our exhibits: * We are focusing entirely exclusively on cash flows created by this project; incremental cash flows generated by undertaking of this project. The analysis focuses on the difference between cash flows Tasty Foods will incur if High Energy-Lite is implemented, versus the cash flows it will have, if rejected. Only relevant cash flows are considered. * Depreciation is non-cash charge and commonly deducted from accounting income to shelter income from taxation. Although, it has an impact on cash flows, depreciation itself is not a cash flow. Therefore, this non-cash charge is added back to correctly evaluate the profitability of High Energy-Lite. * High Energy-Lite’s cash flows are discounted at the appropriate overall cost of capital (WACC = 12%). If this project will be financed in part by debt, the interest expense is irrelevant to this analysis, because the cost of debt is already embedded in the stated 12% cost of capital. * The $262,500 test marketing program carried out earlier this year will not be recovered in the future, regardless of whether this...
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