Question

Chew On This

NEW YORK—Caron Proschan finished lunch and reached for a piece of chewing gum. In contrast to the organic juice and salad she just finished, the gum was a mix of “alien” colors and chemicals. “I thought … there must be a natural gum,” insists Caron. “After researching it, I found out there wasn’t one.” So, Caron launched her company, Simply Gum (SimplyGum.com).

Simply Gum is made using natural flavors, a natural chicle base, organic ingredients, and no synthetics. “We experimented with a lot of ingredients and flavors,” explains Caron. Compared with its two main competitors, which have 95% of U.S. gum sales, Simply Gum can quickly change its manufacturing process, flavors, and distribution. “Our recipe is never done,” exclaims Adeena Cohen, senior marketing manager. “We’re constantly perfecting flavor and texture.”

Caron uses contribution margins to decide whether adding new flavors would increase profits and whether to eliminate less profitable flavors. Unlike some companies that can rework substandard materials, Caron explains that “raw materials that don’t meet our standards never enter our production process.”

In addition to profits, Caron considers qualitative factors, including customer satisfaction. “We found out that people really want a better-for-you gum option,” insists Caron.

In addition to short-term decisions involving sales mix, Simply Gum confronts long-run decisions on capital investments. “I assumed we’d find a contract manufacturer to make our gum, and we would figure out packaging, marketing, and sales,” recalls Caron. “It turns out there was no manufacturer to make it, so we make it.” This required Caron to consider the size of her manufacturing plant and the number and types of machines to use. Capital budgeting techniques—like payback period, net present value, and internal rate of return—help guide her.

Simply Gum now is sold in over 1,200 stores in the U.S. “We believe we’ve found a niche,” proclaims Caron. She insists others can do the same if they “stay focused, work hard, and seek guidance.”

BTN 24-7 Read the chapter opener (above) about Caron Proschan and her company, Simply Gum. Suppose Caron’s business continues to grow, and she builds a massive new manufacturing facility and warehousing center to make her business more efficient and reduce costs.

Required

1. What are some of the management tools that Caron can use to evaluate whether the new manufacturing facility and warehousing center will be a good investment?

2. What information does Caron need to use the tools that you identified in your answer to part 1?

3. What are some of the advantages and disadvantages of each tool identified in your answer to part 1?

Answer 1

1) The management tools which can help Caron in deciding whether investment in new plant and machinery would be beneficial or not may include techniques such as Net Present Value and Internal Return of Return.
Using both these techniques, Caron would be able to estimate the cost of capital for the firm and also at the same time understand whether, investment in the plant and machinery is worthwhile since a positive NPV is indicative of a profitable investment and a negative NPV investment should be avoided.
Similarly, if the returns generated through these investments as denoted by IRR are higher than cost of capital, then these investments should be chosen for implementation.

2) For implementing these techniques, Caron would need information regarding cost of capital of the firm and also estimated cash flows expected from the investments and the initial investment required for the firm.

3) The advanatges of the techniques mentioned are that these are robust and would give accurate information on whether to proceed with the investment or not.

The disadvantages are that these would need additonal data gathering and large amount of calculations to correctly arrive at the investment decision. Moreover IRR rule is also susceptible to spurious results in case of cash flows not following an uniform pattern.