Mini-Case: Cupcake Project Cash Flow

Adapted from Chapter 11 Mini-Case in Foundations of Finance

Gammy is considering building a facility to manufacture cupcakes to distribute nationally. Your assignment involves both the calculation of cash flows associated with the new investment under consideration and the evaluation of several mutually exclusive projects. Grammy wants you to meet with everyone involved and write a meeting report for the board of directors that includes your recommendation. In addition to the recommendation, you have been asked to respond to a number of questions aimed at understanding the capital-budgeting process. Grammy wants to be sure that she and the board of directors understand cash flow and capital budgeting.

We are considering constructing a building to manufacture cupcakes. Currently we are in the 34 percent marginal tax bracket with a 15 percent required rate of return or cost of capital. This project is expected to last 5 years and then, because this is somewhat of a fad product, be terminated. The following information describes the project:

Cost of new plant and equipment	$7,900,000
Shipping and installation costs	$   100,000
Unit Sales	Year                     Units Sold 1                                         70,000 2                                        120,000 3                                        140,000 4                                         80,000 5                                         60,000
Sales price per unit	$300/unit in years 1 through 4, $260/unit in year 5
Variable cost per unit	$180/unit
Annual fixed costs	$200,000 per year in years 1 – 5
Working-capital requirements	There will be an initial working-capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10 percent of the dollar value of sales for that year.   Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5.
The depreciation method	Use the simplified straight-line method over 5 years. Assume the plant and equipment will have no salvage value after 5 years.

1. Read Chapter 11 of your textbook. As you read, consider how you will evaluate the Cupcake Project Cash Flow and what recommendation you will make to Grammy and the board.
2. Download FIN 310 Foundations of Finance Chapter 11.ppt and review it to further your understanding of this chapter.
3. Review the section of chapter 5 in Management Communications: A Case Study Approach related to meeting reports.
4. Review Genesis 47: 18 – 19 and consider how it relates to this project. Feel free to supplement your application of biblical truth with other passages of scripture.
5. Download and read the Mini-Case Cupcake Project Cash Flow and develop a meeting report that answers the following questions:
   1. Should you focus on cash flows or accounting profits in making the capital-budgeting decision? Should you be interested in incremental cash flows, incremental profits, total free cash flow, or total profits?
   2. How does depreciation affect free cash flow?
   3. How do sunk costs affect the determination of cash flows?
   4. What is the project’s initial outlay?
   5. What are the differential cash flows over the project’s life?
   6. What is the terminal cash flow?
   7. Draw a cash-flow diagram for this project.
   8. What is its net present value?
   9. What is its internal rate of return?
   10. Should the project be accepted? Why or why not?
   11. How does Genesis 47: 18 – 19 relate to this project and cash flow management?
6. Your meeting report should:
   1. Answer the questions stated above.
   2. Focus on.
      1. What action is required?
      2. Who is responsible?

• What the timing will be.

3 Pages

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