Internal Code - MAS1631
John Rich the co-owner of Rich Confectionaries and plant manager picked up the telephone to call the firm& Sales Manager. The Sales Manager had sent him an email suggesting that Rich Confectionaries might be able to increase its profits substantially if he were allowed to increase the production capacity for a new home brand chocolate that he planed to introduce for sale in convenience stores. The plan was to provide convenience stores, like “7 eleven”
with their own brand of chocolate for sale at the counter. It would be a high-margin product that was currently being sold in bulk to large department stores for their own use in house branding sales. If they went ahead with this new product the company would be able to sell the new product at a higher price than the current price to department stores. The Sales Manager was really pushing this point to John, however his real motivation was that he was
banking on getting a big increase in his bonus payment. " Your suggestion interests me, said John Rich, & but I can't give you an answer until the financials have been worked up to show that profits from the increased sales you expect to get will give us a big enough return on our capital investment”. As soon as you have firm estimates for sales and how much you will need for advertising and promotion, give them to Stephanie Rich (the company's controller and another major owner). She can get the other data she needs to make the calculations from purchasing and production, and I will ask her to send me her recommendation by early next week. If it is as profitable as you think it will be, we will move on it immediately."
Both Stephanie and Sales Manager agree that the new facility should be able to operate profitably for many years. The Rich board had decided that a study life of ten years, the standard used by the company, would be employed in the analysis. At the end of ten years, the market value of the plant is estimated to be $500,000 but the equipment (chocolate moulds, cooking pans and wrapping equipment) will be worth nothing. It is assumed that the
full value of the working capital can be recovered. When evaluating capital projects Stephanie uses a real cost-of- capital of 15 percent and a tax rate of 30 percent. Rich Confectionaries also has a company policy of using straight-line depreciation for management reporting purposes over the life cycle of the product. Under the tax guidelines, the new equipment is classified as a five-year asset and is eligible for a 20% straight-line depreciation rate.
1. Identify the incremental cash flows for this project (ie produce a table of the incremental cashflows for capital budgeting analysis). Please use the excel spreadsheet on UTS online for this task failure to do so may cost
2. Write a brief executive summary to John Rich giving your recommendation? Include a summary of your workings supporting your recommendation. Make sure you look at the guide to writing assignments on how to do an executive
summary which must not be more than one page in length
3. Sales Manager used the payback period as an indicator of the merit of the move to the new facility. Is this decision criterion the one that should be used? Give reasons why you would use this criterion and one why you would not.
4. What others factors should Rich Confectionaries consider?