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Sophie Morgan, President of Cayuga Cookies, Inc.




Question;Assignment;Sophie Morgan, President of;Cayuga Cookies, Inc. (CCI), was trying to decide whether to expand the company;by adding a new product line. The proposal seemed likely to be profitable and;adequate funds to finance it could be obtained from outside investors.;CCI had long been regarded as a;well-managed company. It had succeeded in keeping its present product lines up;to date and had maintained a small but profitable position in a highly;competitive industry.;The amount of capital presently;employed by the company was approximately $4,000,000, and was expected to;remain at this level whether the proposal for the new product line was accepted;or rejected. Net income from existing operations amounted to about $400,000 a;year, and Morgan?s best forecast was that this would continue to be the income;from present operations.;Introduction of the new product;line would require an immediate investment of $400,000 in equipment and;$250,000 in additional working capital. A further $100,000 in working capital;would be required a year later.;Sales of the new product line;would be relatively low during the first year, but would increase steadily;until the sixth year. After that, changing tastes and increased competition;would probably begin to reduce annual sales. After eight years, the product;line would probably be withdrawn from the market. At that time, the company;would dispose of the equipment and liquidate the working capital. The cash;value of steps to close the product line at that time would be about $350,000.;The low initial sales volume;combined with heavy promotional outlays, would lead to heavy losses in the;first two years, and no net income would be reported until the fourth year. The;profit forecasts for the new product line are summarized in Exhibit 1.;Morgan was concerned about the;effect this project would have on CCI's overall reported profitability over the;next three years. On the other hand, "eyeballing" the figures in;Exhibit 1 led Morgan to guess that if the proposal were analyzed using;after-tax cash flows discounted at 10 percent, it might well show a positive;net present value, and hence could be a worthwhile investment opportunity.;Exhibit;1;Income;Forecast for New Product Line;Year;Forecasted;Incremental;Cash Flow from;Operations1;(1);Depreciation;Expense on New;Equipment2;(2);Forecasted;Incremental Income;Before Tax;(3) = (1 + 2);Income Tax3 at;40%;(4);Forecasted;Incremental;Net Income After Tax4;(5) = (3 + 4);1;(350,000);(50,000);(400,000);160,000;(240,000);2;(100,000);(50,000);(150,000);60,000;(90,000);3;0;(50,000);(50,000);20,000;(30,000);4;200,000;(50,000);150,000;(60,000);90,000;5;500,000;(50,000);450,000;(180,000);270,000;6;1,000,000;(50,000);950,000;(380,000);570,000;7;900,000;(50,000);850,000;(340,000);510,000;8;650,000;(50,000);650,000;(240,000);360,000;Notes;1. In;this column, numbers in parentheses indicate cash outflow.;2. In;this column, numbers in parentheses indicate an expense (i.e., something that;reduces profits). For the purpose of this;analysis, we may use these depreciation figures for the determination of;both Net Income and Income Tax that will be paid to the government.;3. When;forecasted incremental income before taxes is negative, the firm is entitled to;a tax rebate at 40%, either from taxes paid in previous years or from taxes;currently due on other company operations. Therefore, in this column, numbers;in parentheses indicate taxes paid to the government and numbers not in;parentheses indicates tax rebates received from the government.;4. In;this column, numbers in parentheses indicate a net loss produced by the new;product line and numbers not in parentheses indicate a net profit made by this;new product line.;Required;1. Calculate;the nominal and discounted payback periods for this proposed project.;2. Calculate;the net present value and internal rate of return of the proposed project.;3. Referring;to your analysis in parts (1) and (2), what is your recommendation regarding;the proposed project under the following three scenarios (note: comment on any;similarities or differences in your recommendations across these three;scenarios);a. If;CCI was a private company, owned entirety by Sophie Morgan?;b. If;CCI was a publicly owned company, with shares owned by a large number of small;investors, and Morgan purely a salaried administrator?;c. If;CCI was a wholly owned subsidiary of a much larger company and Morgan expected;to be a candidate to succeed one of the parent company's top executives who;will retire from the company in about two years from now?


Paper#41451 | Written in 18-Jul-2015

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