Question

Ma’s Meat Sauce has come up with a new product, Slow Cook Meat Sauce, to provide a superior spaghetti sauce cooked over a longer period. Ma paid $130,000 for a marketing survey to determine the viability of the products, including pricing and projected sales. They believe they will generate sales of $890, 000 in year 1, $900,000 in year 2, $910,000 in year 3 and in the final year $900,000. Fixed costs are estimated at $230,000 per year and variable costs will amount to 22% of sales. The machines required for production (a new cooker and bottling line) will cost $1,000,000 and will be depreciated using the straight-line method over the 4 years. Ma pays 30% in Tax and has a required rate of return of 14%

1. Calculate the NPV showing your pro forma profit and loss OR a cash flow table. Explain if Ma should go ahead with the project. (Explanation should be approx. 200 words)

2. Identify which capital budgeting method tends to favour liquidity over value maximization and how might this affect the investment decision?

3. Why do we favour NPV, even though it also has problems as a capital budgeting method?

4. We often us scenario and sensitivity analysis to help in capital budgeting decision making. In a situation where you want to identify the key variables that have most influence on a project, which method would you use? Why? Give an example of each method. (250 words approx.)

Answer 1