Case 2: Betsy’s Best: Capital Budgeting
EXECUTIVE SUMMARY
Question 1: Define the term “incremental cash flow”. Since the company will finance the project in part by debts, should the
cash flow statement include intere
...
Case 2: Betsy’s Best: Capital Budgeting
EXECUTIVE SUMMARY
Question 1: Define the term “incremental cash flow”. Since the company will finance the project in part by debts, should the
cash flow statement include interest expense? Explain.
Question 2: What is Betsy’s Best Year 0 net investment outlay for the new equipment expansion project?
Question 3: If the company decides to expand with the additional production machine, is the existing space that Betsy’s Best in
the production facility “free” or “costless”? Explain how the rent the company currently receives for space in the facility
should be should be included in the analysis.
Question 4: The addition of competing product lines with a lower grade cheese has been raised.
a. What additional concerns about the premium cheese expansion must be considered if the company decides to introduce a
competitive product to existing offerings? How would Betsy’s Best decision to purchase the new expansion machine be
affected?
Question 5: What are the expected non-operating cash flows when the company terminates the project at year 10?
Question 6: Estimate the project’s net cash flows for each year of the project’s economic life.
Question 7: What discount rate should be used as the company’s cost of capital?
Question 8: Compute the project’s NPV, IRR, MIRR, and payback, and explain the rationale behind each of these capital
budgeting models.
Question 9: Based on this model, explain why the project should or should not be undertaken. Are there any conflicting
decisions possible with the various capital budgeting models?
Question 10: A market-determined nominal cost of capital as the discount rate includes the inflation premium. However, the
sale price and operating cost per unit were assumed to remain constant through the project’s life.
a. What are the problems with an analysis in which the discount rate is in nominal terms but cash flows are measured in
current dollar term, unadjusted for inflation?
not be affected by inflations.
Question 11: Answer this question quantitatively only if you are using the spreadsheet model. Consider the effects of inflation
on sales price and variable operating costs with inflation beginning after year 0. For simplicity, assume that no other CFs are
affected by inflation. Find the project’s NPV, IRR, MIRR, and payback with inflation taken into account.
a. What impact would a 4-percent inflation rate on price (beginning after year 0) and a 2-percent annual increase in cash
Question 13: Should the money spent on investigating the new technology be included in the packaging and labeling machine
analysis? Explain.
Question 14: Calculate each project’s single-cycle NPV. Based on these values, which project would be undertaken?
Question 15: After adjusting for the life of the projects using the EAA and replacement chain approach, which
recommendations should be made to the Co-op? Briefly, justify your decision.
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