Basil Robekins has an idea for a new type of ice cream cone made from candy bars
ID: 2473533 • Letter: B
Question
Basil Robekins has an idea for a new type of ice cream cone made from candy bars (like Butterfinger, etc.). He bounced this idea off of his current customers and thinks they will buy more often because they can pick and choose from over 31 different candy bars and won’t get bored with the selection of either a sugar or a waffle cone. He would like to try out his idea in an adjacent state because they are offering some tax benefit. He has a location selected where the demographics are similar to his current location. However, he will need to upgrade to a more flexible cone maker that can adjust to the different hardness of each type of candy bar. He has located such a cone maker for a cost of $40,000. He knows this will be a big risk for him and remembers how his brother-in-law got burned buying a $20,000 tunnel oven for “super-duper long” pizzas. Basil thinks he can get 5 years out of the flexible cone maker. But he knows that is what his brother-in-law thought about the tunnel oven which lasted only 3 years. Basil also knows that nobody will want his flexible cone maker because the corn syrup in most candy bars leaves a really ugly stain on the metal. However, he knows a scrap metal dealer who will haul away any equipment for free. He has done some market research, mostly surveying his customers and figures he can increase his annual sales by 27%. This would translate into an extra profit of $11,000 per year.
a) Which one of the following suggested risk-adjusted interest rates table below most closely represents Basil’s idea?
Answer: < 10 pts>
Suggestion: Look carefully at the scenario and quote specific items from it that support your answer.
Reasoning:
Rate (%)
Applies to:
6
Equipment replacement
8
New equipment
10
New product in normal market
12
New product in related market
16
New product in new market
20
New product in foreign market
b) Based on a present worth analysis, find the IRR of Basil’s idea.
Suggestion: The PW will include the first cost and the annual savings.
Answer:
Reasoning/Work.
c) Would you recommend Basil by the new machine or not?
Answer:
Reasoning/Work.
Rate (%)
Applies to:
6
Equipment replacement
8
New equipment
10
New product in normal market
12
New product in related market
16
New product in new market
20
New product in foreign market
Explanation / Answer
a) Which one of the following suggested risk-adjusted interest rates table below most closely represents Basil’s idea? Answer: < 10 pts> The rate which applies for this project is "New Product in New Market", since the ice cream cone is a new product which Basil is planning to introduce, and in an adjacent state, owing to the tax benefits available. This means that the product is new, and so is the market for the same. Suggestion: Look carefully at the scenario and quote specific items from it that support your answer. Reasoning: Rate (%) Applies to: 6 Equipment replacement 8 New equipment 10 New product in normal market 12 New product in related market 16 New product in new market 20 New product in foreign market b) Based on a present worth analysis, find the IRR of Basil’s idea. Suggestion: The PW will include the first cost and the annual savings. Answer: Based on a Net Present Value analysis, given that the cost of capital is 16% the NPV of the Project conceived by Basil works out to -$3,433.42 Further, the IRR using the Trial-and-Error method works out to 11.65% Reasoning/Work. c) Would you recommend Basil by the new machine or not? Answer: Since the IRR of the Project is lower than the cost of capital of 16%, Reasoning/Work. it would be recommended that Basil not buy the new machine, as it is expected to incur losses in the long run.Related Questions
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