Reference no: EM131208678
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.
1. What is/are the sunk cost(s) for this new frozen premium stir fry meal project? Briefly explain. You have to tell what sunk cost is and the amount of the total sunk cost(s). In addition, you have to advise HF on how to handle such cost(s). 2. What are the cash flows of the project for each year? 3. What is the payback period of the project? Should it be accepted if HF requires a payback of 4 years for all projects? 4. What is the PI (profitability index) of the project? 5. What is the IRR (internal rate of return) of the project? 6. What is the NPV (net present value) of the project? 7. Should the project be accepted based on PI, IRR and NPV? Briefly explain.
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: 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 pr..
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