CO 500: Managerial Economics

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1.
value:
2.50 points

The demand curve for product X is given by QXd = 380 – 5PX.

a. Find the inverse demand curve.

PX = – QXd

Instructions: Round your answer to the nearest penny (2 decimal places).

b. How much consumer surplus do consumers receive when Px = $55?

$

c. How much consumer surplus do consumers receive when Px = $35?

$

d. In general, what happens to the level of consumer surplus as the price of a good falls?

The level of consumer surplus
as the price of a good falls.

ou are the manager of an organization in America that distributes blood to hospitals in all 50 states and the District of Columbia. A recent report indicates that nearly 50 Americans contract HIV each year through blood transfusions. Although every pint of blood donated in the United States undergoes a battery of nine different tests, existing screening methods can detect only the antibodies produced by the body’s immune system – not foreign agents in the blood. Since it takes weeks or even months for these antibodies to build up in the blood, newly infected HIV donors can pass along the virus through blood that has passed existing screening tests. Happily, researchers have developed a series of new tests aimed at detecting and removing infections from donated blood before it is used in transfusions. The obvious benefit of these tests is the reduced incidence of infection through blood transfusions. The report indicates that the current price of decontaminated blood is $60 per pint. However, if the new screening methods are adopted, the demand and supply for decontaminated blood will change to

Qd = 210 – 1.5P and Qs = 2.5P – 150.

What price do you expect to prevail if the new screening methods are adopted? How many units of blood will be used in the United States? What is the level of consumer and producer surplus? Illustrate your findings in a graph.

Instruction: Round your answers to the nearest whole number.

Price: $

Units of blood:

Consumer surplus: $

Producer surplus: $

You are an assistant to a senator who chairs an ad hoc committee on reforming taxes on telecommunication services. Based on your research, AT&T has spent over $15 million on related paperwork and compliance costs. Moreover, depending on the locale, telecom taxes can amount to as much as 25 percent of a consumer’s phone bill. These high tax rates on telecom services have become quite controversial, due to the fact that the deregulation of the telecom industry has led to a highly competitive market. Your best estimates indicate that, based on current tax rates, the monthly market demand for telecommunication services is given by Qd = 250 – 5P and the market supply (including taxes) is QS = 3P – 130 (both in millions), where P is the monthly price of the telecommunication services.

The senator is considering tax reform that would dramatically cut tax rates, leading to a supply function under the new tax policy of QS = 3.2P – 130. How much money per unit would a typical consumer save each month as a result of the proposed legislation?

Instruction: Round your answer to the nearest penny (2 decimal places).

$

G.R. Dry Foods Distributors specializes in the wholesale distribution of dry goods, such as rice and dry beans. The firm’s manager is concerned about an article he read in this morning’s The Wall Street Journal indicating that the incomes of individuals in the lowest income bracket are expected to increase by 10 percent over the next year. While the manager is pleased to see this group of individuals doing well, he is concerned about the impact this will have on G.R. Dry Foods.

What do you think is likely to happen to the price of the products G.R. Dry Foods sells? Why?

The price will increase, because dry beans and rice are inferior goods.
The price will increase, because dry beans and rice are normal goods.
The price will decrease, because dry beans and rice are inferior goods.
The price will decrease, because dry beans and rice are normal goods.

As a result of increased tensions in the Middle East, oil production is down by 1.21 million barrels per day – a 5 percent reduction in the world’s supply of crude oil. Explain the likely impact of this event on the market for gasoline and the market for small cars.

The gasoline market will have:

lower equilibrium prices and higher equilibrium quantity.
lower equilibrium prices and lower equilibrium quantity.
higher equilibrium prices and higher equilibrium quantity.
higher equilibrium prices and lower equilibrium quantity.

The small car market will have:

lower equilibrium prices and lower equilibrium quantity.
higher equilibrium prices and lower equilibrium quantity.
lower equilibrium prices and higher equilibrium quantity.
higher equilibrium prices and higher equilibrium quantity.

Answer the following questions based on the accompanying diagram:

Instructions: All dollar responses should be entered as whole numbers. Include a minus (-) sign for all negative answers.

a. How much would the firm’s revenue change if it lowered price from $12 to $10? Is demand elastic or inelastic in this range?

Revenue change: $

Demand is in this range

b. How much would the firm’s revenue change if it lowered price from $4 to $2? Is demand elastic or inelastic in this range?

Revenue change: $

Demand is in this range

c. What price maximizes the firm’s total revenues? What is the elasticity of demand at this point on the demand curve?

Price that maximizes total revenues: $

Demand is at this point

The demand curve for a product is given by QXd = 1,200 – 3PX – 0.1PZ where Pz = $300.

a. What is the own price elasticity of demand when Px = $140? Is demand elastic or inelastic at this price? What would happen to the firm’s revenue if it decided to charge a price below $140?

Instruction: Round your response to 2 decimal places.

Own price elasticity:

Demand is:

If the firm prices below $140, revenue will:

b. What is the own price elasticity of demand when Px = $240? Is demand elastic or inelastic at this price? What would happen to the firm’s revenue if it decided to charge a price above $240?

Instruction: Round your response to 1 decimal place.

Own price elasticity:

Demand is:

If the firm prices above $240, revenue will:

c. What is the cross-price elasticity of demand between good X and good Z when Px = $140? Are goods X and Z substitutes or complements?
Instruction: Round your response to 2 decimal places.

Cross-price elasticity:

Goods X and Z are:

Suppose the own price elasticity of demand for good X is -3, its income elasticity is 1, its advertising elasticity is 2, and the cross-price elasticity of demand between it and good Y is -4. Determine how much the consumption of this good will change if:

Instructions: Enter your answers as percentages. Include a minus (-) sign for all negative answers.

a. The price of good X decreases by 5 percent.

percent

b. The price of good Y increases by 8 percent.

percent

c. Advertising decreases by 4 percent.

percent

d. Income increases by 4 percent.

percent

Suppose the own price elasticity of demand for good X is -4, its income elasticity is 3, its advertising elasticity is 2, and the cross-price elasticity of demand between it and good Y is -4. Determine how much the consumption of this good will change if:

Instructions: Enter your answers as percentages. Include a minus (-) sign for all negative answers.

a. The price of good X decreases by 6 percent.

percent

b. The price of good Y increases by 7 percent.

percent

c. Advertising decreases by 4 percent.

percent

d. Income increases by 3 percent.
percent

Suppose the cross-price elasticity of demand between goods X and Y is -2. How much would the price of good Y have to change in order to change the consumption of good X by 10 percent?

percent

11.
value:
2.50 points

Revenue at a major cellular telephone manufacturer was $2.3 billion for the nine months ending March 2, up 77 percent over revenues for the same period last year. Management attributes the increase in revenues to a 122 percent increase in shipments, despite a 38 percent drop in the average blended selling price of its line of phones.

Given this information, is it surprising that the company’s revenue increased when it decreased the average selling price of its phones?

Yes. Own price elasticity is -3.21, which means demand is elastic and a decrease in price will decrease revenues.
No. Own price elasticity is -3.21, which means demand is elastic and a decrease in price will raise revenues.
Yes. Own price elasticity is -0.31, which means demand is inelastic and a decrease in price will decrease revenues.
No. Own price elasticity is -0.31, which means demand is elastic and a decrease in price will raise revenues.

For the first time in two years, Big G (the cereal division of General Mills) raised cereal prices by 5 percent. If, as a result of this price increase, the volume of all cereal sold by Big G changed by -6 percent, what can you infer about the own price elasticity of demand for Big G cereal?

It is .

Can you predict whether revenues on sales of its Lucky Charms brand increased or decreased?

Yes – it increased.
No – you can’t tell.
Yes – it decreased.

 
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Data Visualization Methods

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Managerial Report

Use the data visualization methods presented in this chapter to explore these data and discover relationships between the variables. Include the following, in your report:

1. Create a scatter chart to examine the relationship between the year released and the inflation-adjusted U.S. box office receipts. Include a trendline for this scatter chart. What does the scatter chart indicate about inflation-adjusted U.S. box office receipts over time for these top 50 movies?

2. Create a scatter chart to examine the relationship between the budget and the noninflation-adjusted world box office receipts. (Note: You may have to adjust the data in Excel to ignore the missing budget data values to create your scatter chart. You can do this by first sorting the data using Budget and then creating a scatter chart using only the movies that include data for Budget.) What does this scatter chart indicate about the relationship between the movie’s budget and the world box office receipts?

3. Create a frequency distribution, percent frequency distribution, and histogram for inflation-adjusted U.S. box office receipts. Use bin sizes of $100 million. Interpret the results. Do any data points appear to be outliers in this distribution?

4. Create a PivotTable for these data. Use the PivotTable to generate a crosstabulation for movie genre and rating. Determine which combinations of genre and rating are most represented in the top 50 movie data. Now filter the data to consider only movies released in 1980 or later. What combinations of genre and rating are most represented for movies after 1980? What does this indicate about how the preferences of moviegoers may have changed over time?

5. Use the PivotTable to display the average inflation-adjusted U.S. box office receipts for each genre–rating pair for all movies in the dataset. Interpret the results.

 
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Reflection Paper Of A Bargaining Exercise

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I played a buyer role to buy a plant in this negotiation class. I need a reflection paper of this exercise. I did a negotiation with my partner. I upload the case,

Reflection Paper Assignment Instructions, our contents of the negotiation and the discussion that I wrote in this case.

The reflection paper have to include these questions:

 

1. Summary: What happened in the exercise?
2. Analysis: Why did the negotiation happen the way it did?

3. Takeaways: What did you learn from doing this exercise? What will you do differently the next time?

 

The format of the reflection paper should follow these guidelines:
ď‚· Length = 3-4 pages, double-spaced, Font = Times New Roman 12 pt, Margins = 1 inch

© 2000-2014 Dispute Resolution Research Center (DRRC), Kellogg School of Management, Northwestern University. All rights reserved. DRRC/KTAG teaching materials are protected by copyright law. DRRC requires a per person royalty for use of its exercises. Each purchase of an exercise authorizes copying or electronic distribution of that exercise equal to the quantity purchased. Access DRRC/KTAG materials at www.negotiationexercises.com Contact DRRC at [email protected]

 

Creative Consensus, Inc. box 473, HCR 33, Spruce Head, ME 04859

phone: 207-596-6373 fax: 207-596-0538 email: [email protected]

 

THE BIOPHARM-SELTEK NEGOTIATION Formerly known as Synertech-Dosagen Leonard Greenhalgh Amos Tuck School, Dartmouth College Role for BioPharm, CFO You are the Chief Financial Officer of BioPharm, a U.S.-based pharmaceutical company that has annual sales of $700 million. You need to buy or build a plant in the U.S. to produce a genetically engineered (“biotech”) antibiotic compound, Depox. You bought a license from the Belgian company that developed Depox. The Belgian company sold the license because they don’t have the plant capacity or other resources to expand the business beyond the European market. The licensing agreement gives you exclusive rights to manufacture and sell Depox in North America. It makes the most sense to manufacture Depox in the U.S. because this is your biggest market. Depox has great market potential, and it complements BioPharm’s existing product line of conventional antibiotics. A special plant is needed because manufacturing genetically engineered compounds requires special water-processing facilities. You cannot modify an existing BioPharm plant because none of these is set up to handle “biotech” manufacturing with its special water processing requirements. You have two choices: you can build a new plant or buy a plant that is already set up to manufacture genetically engineered compounds. It will cost $25 million to build a new plant. It will take 12 months from the time you break ground to the time when the first shipments of Depox will reach the U.S. market. Part of that time is taken up with getting the FDA (the U.S. Food and Drug Administration) to approve the plant for pharmaceutical manufacturing and to train a new work force in special biotech

manufacturing techniques. The Depox compound has already been approved by the FDA. Depox is ready for manufacture right now, and you would like to begin production as soon as possible, since time-to-market is a huge competitive advantage. In an ideal world, you would find a “turn-key” plant that you could move into immediately and start operating at the end of this month. Each month you wait for the plant to be ready for production costs BioPharm $1 million in lost profits. These profits cannot be recovered later: a sick patient can’t wait for an antibiotic. Anticipating that you will have to build—rather than buy—a plant, you have located a suitable site in a new industrial park 10 miles from your U.S. headquarters’ operations. You need to commit to buying or not buying that site very soon, otherwise you might lose it. You took out a 90-day option to purchase that site for $500,000. Your option expires tomorrow. (It cost you $10,000 for that option and you will lose the $10,000 if you don’t purchase the land tomorrow. If you do purchase the land, the $10,000 will be credited toward the purchase price.) In the meantime, you discovered that Seltek, a smaller pharmaceutical company with annual sales of $150 million, has a suitable U.S. plant for sale. The location is not great—it is 70 miles away from your U.S. headquarters facilities where the research group is located—but Seltek’s plant is running and already has FDA approval. It also has a high-quality, experienced work force which could save you the costs and time of hiring and training your own

 

 

 

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Creative Consensus, Inc.

workers. If you were to buy the plant, you very much want to take over operating it as soon as Seltek ceases operations. You don’t want them to shut down the plant and leave it idle for a while, because the workers may take other jobs. Thus, the Seltek plant seems like an ideal “turnkey” facility. Your plant engineers have assured you that BioPharm could start up Depox production and distribution immediately. In addition to selling the plant, Seltek wants to sell the patent on Petrochek, the compound it has been manufacturing at the plant. Petrochek is of zero interest to you because it is not a pharmaceutical product and you have no way to distribute it. Petrochek is a genetically engineered bacterium that breaks down oil into water-soluble compounds (and is sold for use in treating oil spills). Your present sales force specializes in pharmaceuticals—selling to doctors, hospitals, HMOs, and drug store chains in the U.S.. The sales force would be useless for selling to the oil industry or to government agencies that deal with water pollution. You would need to set up a new sales force to market Petrochek, but it’s not in your strategic interests to do so. You don’t have any sales people to spare, and you have no one available who could recruit and manage a new sales force for this product. Thus, buying the patent would be inconsistent with BioPharm’s corporate strategy. The Board and CEO have said no to buying the Petrochek patent. You are about to meet with the Chief Financial Officer of Seltek. You have full authority from the Board and CEO to buy the plant at any price you deem acceptable. You have up to $40 million available for investment. To the right is the available information concerning the appraised value of the Seltek plant.

You have learned that Seltek apparently hasn’t been paying real estate taxes and owes $200,000. This would have to be paid by one of the parties to remove the tax lien that would hold up transfer of title. The real estate taxes would be the same at either location you are considering. Seltek Plant The following information is in the public domain and was made available to BioPharm. 1. The plant (i.e., the building and land) was appraised by a real estate agent two years ago at $20 million. The local real estate market has declined 20 per cent in the last two years due to the state of the local economy. 2. Public accounting information shows that the plant is valued at $12 million on Seltek’s accounting statements. The land value is recorded at its original purchase price of $1 million, and the building has been depreciated from an original $20 million down to $11 million, for tax advantages. (The IRS lets a corporation reduce the “book” value of a building every year as if it were “wearing out,” like an automobile does with increasing mileage. The resulting theoretical “loss” in value can be deducted from the company’s tax bill.) 3. The building is insured against total loss (fire, explosion, hurricane, etc.) for $8 million. 4. An identical plot of land across the street from the Seltek plant just sold for $500,000 after being on the market for three years. 5. There are no environmental liabilities pending, but there is a $200,000 tax lien on the property.

 

 

  • THE BIOPHARM-SELTEK NEGOTIATION
    • Formerly known as Synertech-Dosagen
  • Role for BioPharm, CFO

    © 2000-2014 Dispute Resolution Research Center (DRRC), Kellogg School of Management, Northwestern University. All rights reserved. DRRC/KTAG teaching materials are protected by copyright law. DRRC requires a per person royalty for use of its exercises. Each purchase of an exercise authorizes copying or electronic distribution of that exercise equal to the quantity purchased. Access DRRC/KTAG materials at www.negotiationexercises.com Contact DRRC at [email protected]

     

    Creative Consensus, Inc. box 473, HCR 33, Spruce Head, ME 04859

    phone: 207-596-6373 fax: 207-596-0538 email: [email protected]

     

    THE BIOPHARM-SELTEK NEGOTIATION Formerly known as Synertech-Dosagen Leonard Greenhalgh Amos Tuck School, Dartmouth College Role for BioPharm, CFO You are the Chief Financial Officer of BioPharm, a U.S.-based pharmaceutical company that has annual sales of $700 million. You need to buy or build a plant in the U.S. to produce a genetically engineered (“biotech”) antibiotic compound, Depox. You bought a license from the Belgian company that developed Depox. The Belgian company sold the license because they don’t have the plant capacity or other resources to expand the business beyond the European market. The licensing agreement gives you exclusive rights to manufacture and sell Depox in North America. It makes the most sense to manufacture Depox in the U.S. because this is your biggest market. Depox has great market potential, and it complements BioPharm’s existing product line of conventional antibiotics. A special plant is needed because manufacturing genetically engineered compounds requires special water-processing facilities. You cannot modify an existing BioPharm plant because none of these is set up to handle “biotech” manufacturing with its special water processing requirements. You have two choices: you can build a new plant or buy a plant that is already set up to manufacture genetically engineered compounds. It will cost $25 million to build a new plant. It will take 12 months from the time you break ground to the time when the first shipments of Depox will reach the U.S. market. Part of that time is taken up with getting the FDA (the U.S. Food and Drug Administration) to approve the plant for pharmaceutical manufacturing and to train a new work force in special biotech

    manufacturing techniques. The Depox compound has already been approved by the FDA. Depox is ready for manufacture right now, and you would like to begin production as soon as possible, since time-to-market is a huge competitive advantage. In an ideal world, you would find a “turn-key” plant that you could move into immediately and start operating at the end of this month. Each month you wait for the plant to be ready for production costs BioPharm $1 million in lost profits. These profits cannot be recovered later: a sick patient can’t wait for an antibiotic. Anticipating that you will have to build—rather than buy—a plant, you have located a suitable site in a new industrial park 10 miles from your U.S. headquarters’ operations. You need to commit to buying or not buying that site very soon, otherwise you might lose it. You took out a 90-day option to purchase that site for $500,000. Your option expires tomorrow. (It cost you $10,000 for that option and you will lose the $10,000 if you don’t purchase the land tomorrow. If you do purchase the land, the $10,000 will be credited toward the purchase price.) In the meantime, you discovered that Seltek, a smaller pharmaceutical company with annual sales of $150 million, has a suitable U.S. plant for sale. The location is not great—it is 70 miles away from your U.S. headquarters facilities where the research group is located—but Seltek’s plant is running and already has FDA approval. It also has a high-quality, experienced work force which could save you the costs and time of hiring and training your own

     

     

     

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    Creative Consensus, Inc.

    workers. If you were to buy the plant, you very much want to take over operating it as soon as Seltek ceases operations. You don’t want them to shut down the plant and leave it idle for a while, because the workers may take other jobs. Thus, the Seltek plant seems like an ideal “turnkey” facility. Your plant engineers have assured you that BioPharm could start up Depox production and distribution immediately. In addition to selling the plant, Seltek wants to sell the patent on Petrochek, the compound it has been manufacturing at the plant. Petrochek is of zero interest to you because it is not a pharmaceutical product and you have no way to distribute it. Petrochek is a genetically engineered bacterium that breaks down oil into water-soluble compounds (and is sold for use in treating oil spills). Your present sales force specializes in pharmaceuticals—selling to doctors, hospitals, HMOs, and drug store chains in the U.S.. The sales force would be useless for selling to the oil industry or to government agencies that deal with water pollution. You would need to set up a new sales force to market Petrochek, but it’s not in your strategic interests to do so. You don’t have any sales people to spare, and you have no one available who could recruit and manage a new sales force for this product. Thus, buying the patent would be inconsistent with BioPharm’s corporate strategy. The Board and CEO have said no to buying the Petrochek patent. You are about to meet with the Chief Financial Officer of Seltek. You have full authority from the Board and CEO to buy the plant at any price you deem acceptable. You have up to $40 million available for investment. To the right is the available information concerning the appraised value of the Seltek plant.

    You have learned that Seltek apparently hasn’t been paying real estate taxes and owes $200,000. This would have to be paid by one of the parties to remove the tax lien that would hold up transfer of title. The real estate taxes would be the same at either location you are considering. Seltek Plant The following information is in the public domain and was made available to BioPharm. 1. The plant (i.e., the building and land) was appraised by a real estate agent two years ago at $20 million. The local real estate market has declined 20 per cent in the last two years due to the state of the local economy. 2. Public accounting information shows that the plant is valued at $12 million on Seltek’s accounting statements. The land value is recorded at its original purchase price of $1 million, and the building has been depreciated from an original $20 million down to $11 million, for tax advantages. (The IRS lets a corporation reduce the “book” value of a building every year as if it were “wearing out,” like an automobile does with increasing mileage. The resulting theoretical “loss” in value can be deducted from the company’s tax bill.) 3. The building is insured against total loss (fire, explosion, hurricane, etc.) for $8 million. 4. An identical plot of land across the street from the Seltek plant just sold for $500,000 after being on the market for three years. 5. There are no environmental liabilities pending, but there is a $200,000 tax lien on the property.

     

     

    • THE BIOPHARM-SELTEK NEGOTIATION
      • Formerly known as Synertech-Dosagen
    • Role for BioPharm, CFO
 
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Project Management _ Case Study

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Unit 2 Group Assignment

Group Assignment (suggested level of effort by each group member: 4 hours)

Now that your team is assembled, a mini-case is presented below with several questions.  Read the case and prepare responses to the questions.

CASE: Queensland Food Corp

In early January 2003, the senior-management committee of Queensland Food Corp was to meet to draw up the firm’s capital budget for the new year. Up for consideration were 11 major projects that totaled over $20.8 million. Unfortunately, the board of directors had imposed a spending limit of only $8.0 million; even so, investment at that rate would represent a major increase in the firm’s asset base of $65.6 million. Thus the challenge for the senior managers of Queensland Food Corp was to allocate funds among a range of compelling projects nominated for consideration.

The Company

Queensland Food Corp, headquartered in Brisbane, Australia, was a producer of high-quality ice cream, yogurt, bottled water, and fruit juices. Its products were sold throughout two states (Queensland, New South Wales) and two territories (ACT and Northern Territory).  (See Exhibit 1 for map of the company’s marketing region.)

Exhibition 1 (See Attached)

Exhibition 2 (See Attached)

Most members of management wanted to expand the company’s market presence and introduce more new products to boost sales.

Resource Allocation

The capital budget at Queensland Food Corp was prepared annually by a committee of senior managers who then presented it for approval by the board of directors. The committee consisted of five managing directors, the president Chief Executive (CEO), and the chief finance officer (CFO). Typically, the CEO solicited investment proposals from the managing directors. The proposals included a brief project description, a financial analysis, and a discussion of strategic or other qualitative consideration.

As a matter of company policy, investment proposals at Queensland Food Corp were subjected to two financial tests, payback and internal rate of return (IRR). Financial tests were considered hurdles and had been established in 2001 by the management committee and varied according to the type of project:

Exhibition 3 (See Attached)

In January 2003, the estimated weighted-average cost of capital (WACC) for Queensland Food Corp was 10.5 percent. In describing the capital-budgeting process, the CFO, Tony Austin, said, “We use the sliding scale of IRR tests as a way of recognizing differences in risk among the various types of projects. Where the company takes more risk, we should earn more return. The payback test signals that we are not prepared to wait for long to achieve that return.”

At the conclusion of the most recent meeting of the directors, the board voted unanimously to limit capital spending in 2003 to $8.0 million.

Exhibition 4 (See Attached)

1.    Distribution Truck Fleet Replacement/Expansion. Wayne Ramsey proposed to purchase 100 new refrigerated tractor trailer trucks, 50 each in 2003 and 2004. By doing so, the company could sell 60 old, fully depreciated trucks over the two years for a total of $120,000. The purchase would expand the fleet by 40 trucks within two years. Each of the new trailers would be larger than the old trailers and afford a 15 percent increase in cubic meters of goods hauled on each trip. The new tractors would also be more fuel and maintenance efficient. The increase in number of tucks would permit more flexible scheduling and more efficient routing and servicing of the fleet than at present and would cut delivery times and, therefore, possibly inventories. It would also allow more frequent deliveries to the company’s major markets, which would reduce loss of sales cause by stock-outs. Finally, expanding the fleet would support geographical expansion over the long term. As shown in Exhibit 3, the total net investment in trucks of $2.2 million and the increase in working capital to support added maintenance, fuel, pay-roll, and inventories of $200,000 was expected to yield total cost savings and added sales potential of $770,000 over the next seven years. The resulting IRR was estimated to be 7.8 percent, marginally below the minimum 8 percent required return on efficiency projects. Some of the managers wondered if this project would be more properly classified as “efficiency” than “expansion.”

2.    New Plant Construction. Ian Gardner noted that Queensland Food Corp’s yogurt and ice-cream sales in the southeastern region of the company’s market were about to exceed the capacity of its Sydney manufacturing and packaging plant. At present, some of the demand was being met by shipments from the company’s newest most efficient facility, located in Darwin, Australia. Shipping costs over that distance were high however, and some sales were undoubtedly being lost when marketing effort could not be supported by delivery.  Gardner proposed that a new manufacturing and packaging plant be built in ACT, Australia, just at the current southern edge of Queensland Food Corp’s marketing region, to take the burden off the Sydney and Darwin plants.

The cost of this plant would be $2.5 million and would entail $500,000 for working capital. The $1.4 million worth of equipment would be amortized over seven years, and the plant over ten years. Through an increase in sales and depreciation, and decrease in delivery costs, the plant was expected to yield after-tax cash flows totaling $2.4 million and an IRR of 11.3 percent over the next ten years. This project would be classified as a market extension.

3.    Existing Plant Expansion. In addition to the need for greater production capacity in Queensland Food Corp’s southeastern region, its Cairns’ plant had reached full capacity. This situation made the scheduling of routine equipment maintenance difficult, which, in turn, created production-scheduling and deadline problems. This plant was one of two highly automated facilities that produced Queensland Food Corp’s entire line of bottled water, mineral water, and fruit juices. The Cairn’s plant supplied Northern Territory and Queensland (the major market).

The Cairn’s plants capacity could be expanded by 20 percent for $1.0 million. The equipment ($700,000) would be deprecated over seven years, and the plant over ten years. The increased capacity was expected to result in additional production of up to $150,000 per year, yielding an IRR of 11.2 percent. This project would be classified as a market extension.

4.    Fat Free(!) Greek Yogurt/Ice Cream Development/Introduction. David D. Jones noted that recent developments in the European market showing promise of significant cost savings to food producers as well as stimulating growing demand for low-calorie products. The challenge was to create the right flavor to complement or enhance the other ingredients. For ice-cream manufacturers, the difficulty lay in creating a balance that would result in the same flavor as was obtained when using traditional yogurt/ice cream.

$1.5 million would be needed to commercialize a yogurt line that had received promising results in consumer and production tests. This cost included acquiring specialized production facilities, working capital, and the cost of the initial product introduction. The overall IRR was estimated to be 17.3 percent.

Jones stressed that the proposal, although highly uncertain in terms of actual results, could be viewed as a means of protecting present market share, because other high-quality ice-cream producers carrying out the same research might introduce these products; if the HooRoo Cakes brand did not carry a fat free line and its competitors did, the HooRoo Cakes brand might suffer. This project would be classed in the new-product category of investments.

5.    Plant Automation. Ian Gardner also requested $1.4 million to increase automation of the production lines at six of the company’s older plants. The result would be improved throughout speed and reduced accidents, spillage, and production tie-ups. The last two plants the company had built included conveyer systems that eliminated the need for any heavy lifting by employees. The systems reduced the chance of injury to employees; at the six older plants, the company had sustained on average of 75 missed worker-days per year per plant in the last two years because of muscle injuries sustained in heavy lifting. At an average hourly wage of $14.00 per hour, over $150,000 per year was thus lost, and the possibility always existed of more serious injuries and lawsuits. Overall cost savings and depreciation totaling $275,000 per year for the project were expected to yield an IRR of 8.7 percent. This project would be classed in the efficiency category.

6.    Water Treatment (4 plants). Queensland Food Corp preprocessed a variety of fresh fruits at its Brisbane and Darwin plants. One of the first stages of processing involved cleaning the fruit to remove dirt and pesticides. The dirty water was simply sent down the drain and into the like-named rivers.  Recent legislation from the Department of Sustainability, Environment, Water, Population and Communities (Australian Government) called for any waste water containing even the slight traces of poisonous chemicals to be treated at the sources and gave companies four years to comply. As and environmentally oriented project, this proposal fell outside the normal financial tests of project attractiveness. Gardner noted, however, that the wastewater treatment equipment could be purchased today for $400,000; he speculated that the same equipment would cost $1.0 million in four years when immediate conversion became mandatory. In the intervening time, the company would run the risks that Australian Government and local regulators would shorten the compliance time or that the company’s pollution record would become public and impair the image of the company in the eyes of the consumer. This project would be classed in the environmental category.

7.    Market Expansion West (Western Territory) and 8. Market Expansion South (Victoria).  Mick Dell’Orco recommend that the company expand its market westward to include the Western Territory and to the south (Victoria, South Australia and Tasmania).  He believed it was time to expand sales of ice cream, and possibly yogurt, geographically.  It was his theory that the company could sustain expansions in both directions simultaneously, but practically speaking, Dell’Orco doubted that the sales and distribution organizations could sustain both expansions at once.

Each alternative geographical expansion had its benefits and risks.  If the company expanded southward, it could reach a large population with a great appetite for frozen dairy products, but it would also face more competition from local and state ice cream manufacturers.  The southward expansion would have to be supplied by facilities in ACT and New South Wales, at least initially.

Looking to the west, consumers in Western Territory have substantial purchasing power due to the explosion in the mining industry, but the population is significantly less than in the southward expansion geographical area.  Expansion to the west would require building consumer demand and planning for future plants to produce products in Western Territory.  Expansion to the west would need to be supplied by rail from Darwin facilities and further redistribution truck fleet.

The initial cost for each proposal was $2 million in working capital.  The bulk of the costs were expected to involve the financing of distributorships, but over the ten-year forecast period, the distributors would gradually take over the burden of carrying receivables and inventory.  Both expansion proposals assumed the rental of suitable warehouse and distribution facilities.  The after-tax cash flow was expected to be $3.75 million for southward expansion and $2.75 million for westward expansion.  Dell’Orco pointed out that southward expansion meant a higher possible IRR but that moving westward was a less risky proposition.  The projected IRRs were 21.4 percent and 18.8 percent for southward and westward expansion, respectively.  These projects would be classed in the new market category.

9.    Snack Food Development/Introduction.  David D. Jones suggested that the company use the excess capacity in its Darwin facility to produce a line of snack foods of dried fruits to be test-marketed in Northern Territory.  He noted the strength of the HooRoo brand in that area and the success of other food and beverage companies that had expanded into snack food production.  He also argued that the company’s reputation for wholesome, quality products would be enhanced by a line of dried fruits and that name association with the new product would probably even lead to increased sales of the company’s other products among health-conscious consumers.

Equipment and working capital invests were expected to total $1.5million and $300,000, respectively, for this project.  The equipment would be depreciated over seven years.  Assuming the test market was successful, cash flows from the project would be able to support further plant expansions in other strategic locations.  The IRR was expected to be 20.5 percent, well above the IRR required for new product projects (12 percent).

10.  Computer-based Inventory Control System.  Wayne Ramsey had pressed for three years unsuccessfully for a state-of-the-art computer-based inventory-control system that would link field sales reps, distributors, drivers, warehouses, and possibly retailers.  The benefits of such a system would be shortening delays in ordering and order processing, better control of inventory, reduction of spoilage, and faster recognition of changes in demand at the customer level.  Ramsey was reluctant to quantify these benefits, because they could range between modest and quite large amounts.  This year he presented a cash-flow forecast as part of a business case for the project.  An initial outlay of $1.2 million for the system, followed by $300,000 next year for ancillary equipment.  The inflows reflected depreciation tax shields, tax credits, cost reductions in warehousing, and reduced inventory.  He forecasted these benefits to last for only three years.  Even so, the project’s IRR was estimated to be 16.2 percent.  This project would be classed in the efficiency category.

11.  Bundaberg Rum Acquisition.  Anthony Mitchel had advocated making diversifying acquisitions in an effort to move beyond the company’s mature core business but doing so in a way that exploited the company’s skills in brand management. He had explored six possible related industries, in the general field of consumer packaged goods, and determined that a promising small liquor manufacturer, Bundaberg Rum, offered unusual opportunities for real growth and, at the same time, market protection through branding. He had identified Bundaberg Rum as a well-established brand of liquor as the leading private Australian manufacturer of rum, located in Bundaberg, Queensland.

The proposal was expensive: $1.5 million to buy the company and $2.5 million to renovate the company’s facilities completely while simultaneously expanding distribution to new geographical markets. The expected returns were high: after-tax cash flows were projected to be $13.4 million, yielding an IRR of 28.7 percent. This project would be classed in the new-product category of proposals.

Conclusion

Each member of the management committee was expected to come to the meeting prepared to present and defend a proposal for the allocation of Queensland Food Corp’s capital budget of $8.0 million. Exhibit 3 summarizes the various projects in terms of their free cash flows and the investment-performance criteria.

Exhibition 5 (See Attached)

1Project Number 6 not included

2Equivalent Annuity is that level of equal payments over 10 years that yields a NPV at the minimum required rate of return for that project.  It corrects for

differences in duration among various projects.  In ranking projects based on EA, larger annuities create more investor wealth than smaller annuities.

3Reflects $1.1 million spent initially and at end of year 1

4Free cash flow = incremental profit or cost savings after taxes + depreciation – investment in fixed assets

5$1.5 million would be spent in year one, $2.0 million in year two, and 0.5 million in year 3.

Case Study Questions (100 points)

1.    Financial Analysis:(25 points)

a.    Which NPV of those shown in Exhibit 5 should be used? Why?

b.    Using all NPV forms presented in Exhibit 5, rank the projects.

c.     Since the wastewater treatment project is a cost of doing business, it does not have a NPV.  Suggest a way to evaluate the effluent project.

d.    List the projects that would be funded or unfunded using the financial analysis (include Project 6 in your list)

2.    Weighted Scoring Model Analysis (60 points)

Based on the paper by Englund and Graham (1999), Chapter 2 (Kloppenborg (2017)) and the case information,

a.    Use a scoring model to evaluate and select projects (pp. 45-47, Kloppenborg):

i.    List and define potential criteria

ii.    List and define those criteria that are mandatory (i.e., screening) criteria

iii.    Weight the remaining criteria using an AHP process

b.    Which projects were screened from further consideration in part 2a, ii?

c.     Rank order the remaining projects based on the group analysis.

3.    Were the results different between the financial analysis (Question 1) and the weighted scoring model (Question 2) approach?  If yes, why? (5 points)

Mechanics (10 points) It is expected that the report will have excellent mechanics (presentation, grammar and spelling) exhibit the quality of work capable of a group of graduate students and working professionals.

Your Instructor will use Turn-it-in to ensure your paper is authentic work.  To avoid plagiarism, see the course home page for more information and use the Purdue Online Writing Lab to learn how to paraphrase, summarize and cite the references you use in all academic writing assignments.

Submit your report to the group drop box in Moodle

A strategy for completing this assignment:

Assign one person with responsibility for completing question 1 and preparing the group report.

Assign four people with responsibilities for completing questions2 and 3.

After drafts of all questions are complete, everyone should meet to walk through and discuss the results before

 
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