Hoosier Food, Inc. is a producer of frozen meals. Its current line of stir fries

Question

Hoosier Food, Inc. is a producer of frozen meals. Its current line of stir fries are selling excellently. However, in order to cope with the foreseeable competition with other similar frozen meals, HF spent $150,000 to develop a new line of frozen premium stir fry meals that contain more nutrition and fewer calories, as well as with more distinctive flavors. In addition, these new frozen premium stir fry meals will greatly reduce process time from 12 minutes to 5 minutes for consumers. The company had also spent a further $30,000 to study the marketability of this new line of stir fries. HF is able to produce the new frozen premium stir fry meals at a variable cost of $11.5 each. The total fixed costs for the operation are expected to be $620,000 per year. HF expects to sell 2,100,000 meals, 2,400,000 meals, 1,500,000 meals, 1,250,000 meals and 1,100,000 meals of the new frozen premium stir fries per year over the next five years respectively. The new frozen premium stir fry meals will be selling at a price of $15.3 each. To launch this new line of production, HF needs to invest $7,000,000 in equipment which will be depreciated on a seven-year MACRS schedule. The value of the used equipment is expected to be worth $1,200,000 as at the end of the 5 year project life. HF is planning to stop producing the existing frozen stir fry meals entirely in two years. Should HF not introduce the new frozen premium stir fry meals, sales per year of the existing frozen stir fries will be 700,000 meals and 525,000 meals for the next two years respectively. The existing frozen stir fry meals can be produced at variable costs of $6.5 each and total fixed costs of $450,000 per year. The existing frozen stir fry meals are selling for $13.65 each. If HF produces the new frozen premium stir fries, sales of existing frozen stir fries will be eroded by 600,000 meals for next year and 400,000 meals for the year after next. In addition, to promote sales of the existing frozen stir fry meals alongside with the new frozen premium stir fry meals, HF has to reduce the price of the existing frozen stir fry meals to $10.15 each. Net working capital for the new frozen premium stir fry meal project will be 18 percent of sales and will vary with the occurrence of the cash flows. As such, there will be no initial NWC required. The first change in NWC is expected to occur in year 1 according to the sales of the year. HF is currently in the tax bracket of 35 percent and it requires a 14 percent returns on all of its projects. You have just been hired by HF as a financial consultant to advise them on this new premium stir fry meal project. You are expected to provide answers to the following questions to their management by their next meeting which is scheduled sometime next month. 2. What is the payback period of the project? Should it be accepted if HF requires a payback of 4 years for all projects?

Explanation / Answer

IRR is 153%

IRR is -25% for this proposal.

Payback is taken on investment is done.

So, Decision taken above by the company has a favourable outcome for new frozen stir premium fries.

Assume no loan is taken.

Particulars 0 1 2 3 4 5 Equipment -7000000 Development cost -150000 Marketing cost 6000 6000 6000 6000 6000 Selling Price 15.3 15.3 15.3 15.3 15.3 Variable cost 11.5 11.5 11.5 11.5 11.5 Contribution 3.8 3.8 3.8 3.8 3.8 Sales in Units 2100000 2400000 1500000 12500000 1100000 Contribution amount 7980000 9120000 5700000 47500000 4180000 Fixed cost 620000 620000 620000 620000 620000 Depriciation from 1 1000000 1714300 1224300 874300 NWC 378000 432000 270000 2250000 198000 EBIT is same EBT 5982000 6353700 3585700 43755700 3362000 Less: taxes -2502500 2093700 2223795 1254995 15314495 1176700 Depriciation Add back 1000000 1714300 1224300 874300 0 Sale back of asset 1200000 EAT -2502500 3093700 3938095 2479295 16188795 2376700 PAY-Back 0.808901962

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