You need to analyze the case and come up with the recommendation with regards to the capital budgeting decision.
Assumption: Inflation rate is 4%
1. What is the dilemma faced by the management of Laurentian Bakeries?
2. Comment on the Laurentian Bakeries’ ‘Project Review Process’. Is it a sound process?
3. What are the alternative investment opportunities? Why are those alternatives not chosen?
4. Comment on the expected incremental sales level (e.g. certainty level).
5. How would you incorporate the following information in your analysis? i. Sales price with inflation.
ii. The land cost ($250,000)
iii. Cost associated with administrative staff ($223,000) iv. Sales staff time in securing the contract ($40,000) v. Cost saving due to new line ($0.019 per unit plus $138,000 per year) vi. Operating margin of 15%.
vii. Working Capital: Reduction in average inventory age (by two days) Hint: Find out the current working capital needs in terms of sales days. What will be the net working capital each year?
viii. Cost of Capital: Beta = 0.85; the spread of 2%; difference in market return and long-term government bond of 6%. What is the cost of capital for Laurentian Bakeries? How does it differ from the hurdle rate? ix. Total cash outlay of $5.2 million and corresponding CCA values. x.Ongoing capital expenditure to be equal to annual depreciation.
6. Work on the detail cash flow of the project (Year 0 = 1995; operating years: 1996-2005).
7. Scenario analysis: Think about different scenarios – optimistic, pessimistic etc.
8. What is your decision? Are you missing out any benefit(s) or cost(s)?
Relevant formula for working capital calculation:
Working Capital Needs (as days of sales):
Acc. Rec./(Revenue/365) + Inventory/(Revenue/365) – Acc. Payable/(Revenue/365)