In: Economics
Jason Taylor, CEO of Royal Connection Inc. (RCI) has
to decide on important matters quickly. Some time ago, suddenly,
Jason got an offer from Aberdeen Inc. (AI) to buy the company. RBI
and AI have been playing in the butter cookies market for a very
long time. However, they sell products to different market
segments. Butter cookies from AI with the brand "Yummy" included in
the category of low-priced snacks. Fairly profitable; However, the
margin is not as big. Butter cookies from RCI under the brand name
"Royal". Currently, AI is experiencing financial difficulties in
terms of Cash Flow. Because of this, they plan to sell the company.
RCI holds a 30% market share of butter cookies in value butter. AI
holds a 40% market share in value. Because Royal is 50% more
expensive than Yummy, in terms of units / quantity, Royal's market
share is only 20%. Jason was challenged by shareholders to be more
aggressive, especially in gaining greater market share. Therefore,
they plan to launch a new brand "Excell" that will compete with
"Yummy" head to head in the low-priced butter cookies market. Here
is additional information about "Yummy" and "Excell" for your
consideration. The book value of the AI factory is zero.
Therefore, there is no depreciation expense on profit claims. Over
the past 5 years, "Yummy" profits have approached 1,000 USD and are
expected to earn 1,000 USD from next year onwards. Yummy ad
elasticity is very good at 0.3. AI spends 50 USD per year on
advertising costs. Because they have difficulty in cash flow,
therefore additional spending on advertising will be difficult.
Their profit margin is 10%. AI is considering accepting offers from
RCI based on the same profit assumption for the next 10 years from
cash in. For RCI, if they launch "Excell" they must invest 500 USD
in years 1 through 4 and 200 USD for the year after that. They
expect to get 230USD profit in the first year, 300USD in the second
year and 350USD in the third year. From year 4 to year 8, their
profit will be 450 USD; and the year after, profit is expected to
reach 500 USD. Investment to launch "Excell" is far less than
buying AI. On the other hand, Jason is quite optimistic that if
they buy AI and spend an additional 50 USD per year on ad spending,
they can increase "Yummy" sales and that can justify investment in
AI purchases. Your job as a Business Development Manager is to help
Jason make decisions. "Buy" or "Don't Buy and Launch a new
product". Assume for the calculation of investment, the duration /
length of time the investment calculation is for 20 years. And
assume there are no other factors that influence sales increase
other than the addition of sales due to the addition of
advertisements. The discount rate applied by RCI for investment
calculations is 10%. Question:
1. If Jason, spend an additional 50USD every year on "Yummy" ads
with a profit margin of 10%, calculate the profit that the company
can get as cash in.
2. Based on the information above, what is the asking price from
AI?
3. Assuming the same advertising costs and profits will be valid
for the next 20 years, do the calculation by comparing the two
options (buy or launch a new product). Based on these calculations,
what can you suggest to Jason? "Buy" or "Launch New Product"? Give
the calculation table, the decision and the reason for your
decision.
Question 1
if jason spends additonal $ 50 per year on advertising in addtion to $ 50 per year spent on advertising
we are given that Yummy ad elasticity is very good at 0.3.
therefore, additional $ 50 per year on advertising would increase sales by 30%
therefore addtional $50 per year on advertising would increase profits by 3%
Question 2
The asking price of AI is calculated by subtracting the total expenses from the total revenue. After that discount them at 10% for a period of 10 years as AI is expecting the same profits for the next 10 years.
net cashflow from 'yummy' is $ 950 per year
Question 3
Since same advertising cost and profits are valid for the next 20 years
if jason buys AI then net cashflow will be $ 930 because after buying AI jason will be spending $ 100 yer year on advertising which should be subtracted from annual profits
if jason launches a new product instead of buying AI
year | inflow | outflow | net cashflow |
1 | 230 | 500 | -270 |
2 | 300 | 500 | -200 |
3 | 350 | 500 | -150 |
4 | 450 | 500 | -50 |
5 | 450 | 200 | 250 |
6 | 450 | 200 | 250 |
7 | 450 | 200 | 250 |
8 | 450 | 200 | 250 |
9 | 500 | 200 | 300 |
10 | 500 | 200 | 300 |
11 | 500 | 200 | 300 |
12 | 500 | 200 | 300 |
13 | 500 | 200 | 300 |
14 | 500 | 200 | 300 |
15 | 500 | 200 | 300 |
16 | 500 | 200 | 300 |
17 | 500 | 200 | 300 |
18 | 500 | 200 | 300 |
19 | 500 | 200 | 300 |
20 | 500 | 200 | 300 |
ince the present value of profits from buying AI is greater than the present value of profits from launching a new product, Jason should buy AI.