General Mills decides to produce Warm Delights internally (in-house), they would face an immediate capital expenditure of $5.1 million, and a twelve-month lag before production could start (due to the time required to put the production process, including the microwavable bowl technology, in place). However, if General Mills decides to make Warm Delights production external (outsource), they would face an immediate capital expenditure of only $2.0 million, and production would be available nearly immediately. In either case, associated depreciation would be straight-line over ten years, starting in the first year of production. Since any capital expenditures are heavily customized to the Warm Delights production process, they would have negligible resale or salvage value. General Mills believes that they can receive an average wholesale price of $20 per case for Warm Delights. However, there are various costs associated with production. These include $3.10 for ingredients, $3.50 for manufacturing, $2.50 for packaging, and $0.80 for distribution. These numbers are all per case, and assume internal production; with external production, the manufacturing cost rises to $5.40. In addition to production costs, there are two other significant costs associated with Warm Delights. First, although Betty Crocker is a well-known brand, Warm Delights is a new product, so the cost of direct-to- consumer advertising will be expensive, especially upon the product introduction. This advertising cost is estimated to be $10.0 million in the first year of production, followed by $2.0 million in each subsequent year. The second significant cost is related to product placement, trade deals, and price promotions with retail stores. It is common for food manufacturers to offer deals to food retailers in return for such promotional practices as high-visibility product placement (such at the end of a grocery aisle or in a temporary display case), or temporary retail price reductions (sale prices). The overall cost of such practices for Warm Delights is expected to amount to $3.0 million (an initial investment to secure grocery store shelf space) in the first year of production, plus an additional $3.00 per case sold. The marketing department at General Mills estimates that Warm Delights will generate annual sales volume of 1.5 million cases. (Although this is actually just a "base level scenario," take this to be the projected sales volume.) The marketing department also estimates that, of these sales: 50% will be new dessert sales, 10% will displace sales of other General Mills desserts, and 40% will displace sales of competitors' desserts. The average pretax margin (revenue less expenses) on other General Mills desserts is $4.00 per case. If Warm Delights is launched, it is projected that the end of the product lifetime is a decade from now. General Mills' level of required working capital associated with Warm Delights can be assumed to be equal to 1% of annual product revenue at all times. General Mills faces an 8% cost of capital (discount rate), and a 38% corporate income tax rate. You do not need to consider price inflation. Should General Mills launch Warm Delights? If Warm Delights is launched, should production be internal or external? What do NPV and IRR say about the opportunities that General Mills faces?

General Mills decides to produce Warm Delights internally (in-house), they would face an immediate capital expenditure of $5.1 million, and a twelve-month lag before production could start (due to the time required to put the production process, including the microwavable bowl technology, in place). However, if General Mills decides to make Warm Delights production external (outsource), they would face an immediate capital expenditure of only $2.0 million, and production would be available nearly immediately. In either case, associated depreciation would be straight-line over ten years, starting in the first year of production. Since any capital expenditures are heavily customized to the Warm Delights production process, they would have negligible resale or salvage value. General Mills believes that they can receive an average wholesale price of $20 per case for Warm Delights. However, there are various costs associated with production. These include $3.10 for ingredients, $3.50 for manufacturing, $2.50 for packaging, and $0.80 for distribution. These numbers are all per case, and assume internal production; with external production, the manufacturing cost rises to $5.40. In addition to production costs, there are two other significant costs associated with Warm Delights. First, although Betty Crocker is a well-known brand, Warm Delights is a new product, so the cost of direct-to- consumer advertising will be expensive, especially upon the product introduction. This advertising cost is estimated to be $10.0 million in the first year of production, followed by $2.0 million in each subsequent year. The second significant cost is related to product placement, trade deals, and price promotions with retail stores. It is common for food manufacturers to offer deals to food retailers in return for such promotional practices as high-visibility product placement (such at the end of a grocery aisle or in a temporary display case), or temporary retail price reductions (sale prices). The overall cost of such practices for Warm Delights is expected to amount to $3.0 million (an initial investment to secure grocery store shelf space) in the first year of production, plus an additional $3.00 per case sold. The marketing department at General Mills estimates that Warm Delights will generate annual sales volume of 1.5 million cases. (Although this is actually just a "base level scenario," take this to be the projected sales volume.) The marketing department also estimates that, of these sales: 50% will be new dessert sales, 10% will displace sales of other General Mills desserts, and 40% will displace sales of competitors' desserts. The average pretax margin (revenue less expenses) on other General Mills desserts is $4.00 per case. If Warm Delights is launched, it is projected that the end of the product lifetime is a decade from now. General Mills' level of required working capital associated with Warm Delights can be assumed to be equal to 1% of annual product revenue at all times. General Mills faces an 8% cost of capital (discount rate), and a 38% corporate income tax rate. You do not need to consider price inflation. Should General Mills launch Warm Delights? If Warm Delights is launched, should production be internal or external? What do NPV and IRR say about the opportunities that General Mills faces?

Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter19: Capital Investment

Section: Chapter Questions

Problem 25P

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Please assist in calculating NPV and IRR for the given opportunity

Transcribed Image Text:If General Mills decides to produce Warm Delights internally (in-house), they would face an immediate capital expenditure of $5.1 million, and a twelve-month lag before production could start (due to the time required to put the production process, including the microwavable bowl technology, in place). However, if General Mills decides to make Warm Delights production external (outsource), they would face an immediate capital expenditure of only $2.0 million, and production would be available nearly immediately. In either case, associated depreciation would be straight-line over ten years, starting in the first year of production. Since any capital expenditures are heavily customized to the Warm Delights production process, they would have negligible resale or salvage value. General Mills believes that they can receive an average wholesale price of $20 per case for Warm Delights. However, there are various costs associated with production. These include $3.10 for ingredients, $3.50 for manufacturing, $2.50 for packaging, and $0.80 for distribution. These numbers are all per case, and assume internal production; with external production, the manufacturing cost rises to $5.40. In addition to production costs, there are two other significant costs associated with Warm Delights. First, although Betty Crocker is a well-known brand, Warm Delights is a new product, so the cost of direct-to- consumer advertising will be expensive, especially upon the product introduction. This advertising cost is estimated to be $10.0 million in the first year of production, followed by $2.0 million in each subsequent year. The second significant cost is related to product placement, trade deals, and price promotions with retail stores. It is common for food manufacturers to offer deals to food retailers in return for such promotional practices as high-visibility product placement (such at the end of a grocery aisle or in a temporary display case), or temporary retail price reductions (sale prices). The overall cost of such practices for Warm Delights is expected to amount to $3.0 million (an initial investment to secure grocery store shelf space) in the first year of production, plus an additional $3.00 per case sold. The marketing department at General Mills estimates that Warm Delights will generate annual sales volume of 1.5 million cases. (Although this is actually just a "base level scenario," take this to be the projected sales volume.) The marketing department also estimates that, of these sales: 50% will be new dessert sales, 10% will displace sales of other General Mills desserts, and 40% will displace sales of competitors' desserts. The average pretax margin (revenue less expenses) on other General Mills desserts is $4.00 per case. If Warm Delights is launched, it is projected that the end of the product lifetime is a decade from now. General Mills' level of required working capital associated with Warm Delights can be assumed to be equal to 1% of annual product revenue at all times. General Mills faces an 8% cost of capital (discount rate), and a 38% corporate income tax rate. You do not need to consider price inflation. Should General Mills launch Warm Delights? If Warm Delights is launched, should production be internal or external? What do NPV and IRR say about the opportunities that Gene Mills faces?

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