Reference no: EM13480763

Marques Gourmet Coffee

Jose Ricardo Marques from San Pedro, Brazil is a fourth generation coffee plantation grower.  Jose's great grandfather, Manual, started with 1,000 acres of coffee bean trees in the fertile valley of Brazil in the early 1900s.  Through careful harvesting and production processes, Manual was able to develop a high quality premium coffee bean, which is used in the finest quality coffee blends.  The family now owns close to 50,000 acres of coffee trees and is a major supplier to national companies specializing in gourmet coffee brands.

As Marques Coffee Beans has moved through the generations, family members have assumed various roles in the company operations.  Jose, who grew up with the business, went to the Unites States for his college undergraduate degree and stayed on to earn an MBA degree with an emphasis in entrepreneurial studies.  His goal has always been to start his own coffee company in the United States.

Once Jose finished his college training and earned his masters degree, the family gave him $1,000,000 to establish his business.  Jose decided to locate in New Orleans, which was reasonably close to his supply link of coffee beans with direct air connections to his family farms in San Pedro.  Jose also thought the New Orleans area, with its reputation for quality foods, would be an excellent local market to introduce his new gourmet coffee. 

Jose was considering three different approaches to get his coffee brand produced and marketed in the New Orleans area.  In the first option, he wanted to tie into the current cultural music fad and identify his coffee brand with the local music artists that were popular at the time.  Jose felt that he could get immediate success with large levels of sales in the first two years, but as the fad dies off, his coffee sales would also decline.  By the end of five years, he may have to develop a new brand or at least change the name of the current brand.  This option has some risks as Jose would have to invest a lot of resources and time immediately to get acceptance of his coffee.  He would have to quickly develop an efficient production system, which would also provide a high quality product desired by a wide diversity of users.

A second option Jose was considering was a go-slow approach and develop a coffee brand which would tie in with the scheduled Pan American games in four years.  Brand sales would peak in the fourth and fifth years and possibly decline after the games are over.  This option also had some risks.  While it was not as critical to get the production operations quickly up and running and capturing a market, there was still a considerable cost in initial product development and a commitment to high quality.  There was also some risk that the coffee brand would not gain the large market needed for overall success.

The third option was to just produce a gourmet coffee brand without any connection to a cultural fad or event.  Sales would be aimed at a smaller segment of a target market with the idea of building up a gradual loyal following.  This option probably has the least amount of risk if a general level of acceptance could be obtained.  Changes could be made throughout the time period to refine the production process and product quality.  There would not be the need for as large an expenditure of resources either at the start of the five-year cycle or at the end of the time period. 

Jose wanted to consider the potential returns for each of these three options over a five-year time period.  In using a more conservative approach, he wants to assume that the entire $1,000,000 of up front money would be required at the start of the operation.  $800,000 would be used for equipment purchases, which would be subject to depreciation at $100,000 per year.  The other $200,000 would be for working capital requirements.  Jose is fully anticipating that the business will be successful and he will be continuing the operation for many years to come.  However, for purposes of this analysis he decided to assume that at the end of 5 years he would terminate the coffee production operations and sell all the equipment for 10% of its original value.

Jose developed the following tables for projected revenues and operating costs for each of the next five years for each of the three options he was considering.

Projected Revenues

Years 1 - 5

Dollars in 1,000s

Year	Option 1	Option 2	Option 3
1	$800	$200	$600
2	$1,300	$400	$700
3	$800	$800	$800
4	$500	$1,500	$900
5	$300	$1,800	$1,000

Projected Operating Costs

Years 1 - 5

Dollars in 1,000s

Year	Option 1	Option 2	Option 3
1	$450	$150	$270
2	$650	$200	$300
3	$300	$350	$350
4	$150	$650	$400
5	$100	$750	$450

The projected tax rate for the company is 40%.  Jose believes that any of these coffee brand strategies should bring an 18% return on investment.

Required:

1. Compute the initial outlay for each of these options.

2. Compute the annual cash flows for each of these options.

3. Compute the terminal value for each of these options.

4. Compute the net present value, profitability index, and internal rate of return for each of these options.

5. Identify other factors, which should be considered before deciding which coffee brand strategy, if any, should be selected.

Which option, if any, should be selected and why.