M7.5 milestone 2: investing in capacity

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In this Milestone, we apply tools, knowledge, and insight gained throughout this course. You will be required to:

  • Apply time value of money concepts to determine project value.
  • Assess a project’s expected cash flows.
  • Apply and interpret capital budgeting criteria, including Net Present Value, Payback Period, and Internal Rate of Return.
  • Apply cost-of-capital pricing formulas to assess financing options. Apply and interpret capital budgeting criteria.

Please see Case requirements and Rubric attached below

Grading Criteria

Section A: Explain Components of Project Analysis

1. Weighted Average Cost of Capital (WACC)

Begin your analysis of acquisition by explaining why only some component costs of the firm are included when computing financing costs for this project, concentrating on the choice between a project/divisional cost of capital versus a firm-wide cost of capital approach. (max 400 words) [30 points]

2. Principles for Cash Flow Estimation

  • Consider one Complement sold within each franchise location and one Substitute establishment. (max 200 words) [20 points]
  • Because this CMS will represent an investment in fixed assets, explain whether this decision will change Operating Cash Flow (see Example 2.6 on p. 49 of our required text) and Free Cash Flow (see p. 49 of our required text). (max 100 words) [10 points]

Section B: Evaluate

Evaluation of Alternatives

  • Your evaluation of this potential acquisition requires you to select and apply investment decision rules. In this section, you are to present an evaluation of this acquisition based on an application of the decision rules selected and a summary of benefits and limitations of these capital budgeting techniques. (500 words max) [20 points]
  • Your evaluation of the acceptability of this CMS requires you to supply a recommendation on the acceptability of investment in this project based on the preceding categories of information. In the concluding section, you are to elaborate on the limitations of the above analysis, including what further sources of information you would like to use to make a more informed decision. (400 words max) [20 points]

Milestone 2: Investing in Capacity

Case
Coffee and snack shops are a popular and growing industry in the United States. It is forecasted that they will

continue to grow at rates faster than general economic growth; in 2019, this market was valued at almost 60

billion dollars (Ibis World, 2019). Desserts and other luxury snack items are sometimes marketed as a branded

“experience,” like high-end specialty snack items. To understand how a product can be sold as an experience,

you might think of “Eloise at the Plaza,” the “American Girl Tea Shop” in New York City, an “Escape Room” or

Murder Mystery Nights. Demand for luxury snack items sold as branded experiences increases with disposable

income, or the income that consumers have left over after necessary costs, like shelter and transportation, are

covered. Luxury snack items addressing food allergies and intolerances are also often sold in unique branded

environments. Lactose-free ice cream is one such product.

Competition in the market for luxury snack items is fierce, and franchisees selling these items frequently see the

establishment of close competitors in nearby locations. The success of one establishment may lead to a

mushrooming of similar establishments nearby.

Snack Box (a fictitious company) allows franchisees to market a set of branded items under conditions governing

the nature of the establishment selling the products. Franchise agreements also dictate behavior of employees

presenting items to the public within franchises. As a parent firm, Snack Box oversees multiple franchised

locations and operators. Brands managed by Snack Box include frozen ices and custards, pretzels, waffles and

crepes, moxtails, and related food items. To ensure uniformity across locations, Snack Box requires that all

employees are similarly trained.

Note: A franchise allows a franchisee access to a firm’s proprietary knowledge, processes, and

trademarks or brands. The franchisee pays the franchisor or parent firm an initial start-up fee plus

annual licensing fees. In addition, franchisees pay the parent firm a percentage of revenue outlined in

each franchising agreement.

Assume you are the owner and Chief Financial Officer of Snack Box. You plan to purchase an “off the shelf”

content management system (CMS, or a software application or set of related programs used to create and

manage digital content). The evaluation of the CMS will meet some business requirements of Snack Box:

• Improve employee training and satisfy client training needs: The CMS includes a library of existing

human resources training, compliance, and professional development courses or modules. Training is

interactive, social, and gamified to provide an incentive to complete the required training. Selected

training systems allow authoring and modification of existing courses to meet the needs of various

franchisees, products, locations, and compliance requirements. The CMS should have the ability to host

multiple differently branded websites for the delivery of training information. You expect to increase the

effectiveness of each location as a result.

• Meet the unique financial needs of the parent firm. The CMS needs to be used across a portfolio of

franchise operations offering specialty food items, including custom brewery products and ciders,

crepes, waffles and breakfast dinners.

Snack Box has reviewed project-specific and firm-wide approaches to determining a weighted average cost of

capital to utilize in valuing this project. It has determined that this project has lower firm-specific risk than other

projects in which the firm is involved. You have developed the following capital budgeting criteria based on

expected project cash flows, as follows:

You have determined that the interest rate (risk) assigned to this project is 11% and the maximum allowable

payback (PB) and discounted payback (DPB) periods for Snack Box are 3 and 3.5 years, respectively. You have

determined that the CMS will increase franchise fees and revenues with normal project cash flows shown as

follows:

Project Cash Flows Chart

Time in Years 0 1 2 3 4 5

Cash Flow $235,000 $65,800 $84,000 $141,000 $122,000 $81,200

Applying Net Present Value (NPV), Payback Period (PB), Discounted Payback Period (DPB), and Internal Rate of

Return (IRR) as capital budgeting decision methods and discounting at a rate of 11%, you have evaluated NPV,

PB, DPB and IRR. You have found that these decision rules call for acceptance or rejection of the project as

follows:

As part of your assignment, you will need to interpret the results for the various capital budgeting criteria that

have been provided below. Specific questions will be provided in the project requirement section that follows.

Payback Period Chart

Time in Years 0 1 2 3 4 5

Cash Flow ($235,000) $65,800 $84,000 $141,000 $122,000 $81,200

Cumulative Cash Flow ($235,000) ($169,200) ($85,200) $55,800 $177,800 $259,000

PB: 2.6 years = = 2 + ($85,200/$141,000)

Net Present Value

Time in Years 0 1 2 3 4 5

Cash Flow ($235,000) $65,800 $84,000 $141,000 $122,000 $81,200

Discount (1+.11)0 (1+.11)1 (1+.11)2 (1+.11)3 (1+.11)4 (1+.11)5

Discounted Cash Flow ($235,000) $59,279 $68,176 $103,098 $80,365 $48,188

NPV $124,106.98  

Internal Rate of Return

Time in Years 0 1 2 3 4 5

Cash Flow ($235,000) $65,800 $84,000 $141,000 $122,000 $81,200

Discount (1+IRR)0 (1+IRR)1 (1+IRR)2 (1+IRR)3 (1+IRR)4 (1+IRR)5

0 = ($235,000) $51,091 $68,176 $103,098 $80,365 $48,188

IRR 28.79%
Project Value using IRR $ 115,918.62

Project Requirements
Your task is to prepare a document to make an effective decision regarding the investment in this software and

related equipment. Your document should focus on the following specific explanations within sections A and B.

Section A
Explain the following elements of the decision to acquire this CMS.

1. Weighted Average Cost of Capital (WACC)
Review Example 11.6 and pp. 374-381, 400, and 424 of our required text for more information on Project and

Divisional Costs of Capital. Why is one component of Weighted Average Cost of Capital (WACC) calculated

differently if project risk differs significantly from risk of existing projects (as in this case), than it is when project

risk does not differ significantly from risk of existing projects?

2. Principles for Cash Flow Estimation
• Review pp. 399-400 of our required text for more information on Substitutes and Complements. For

franchise locations, explain how each of the following two factors may affect Snack Box’s NPV estimates:

o One Complement product or service sold within each franchise location, and

o One Substitute establishment (meaning a competing establishment attracted by the success of

the Snack Box franchise).

• Review Example 2.6 on p. 49 of our required text, plus pp. 401-405 of our required text) and Free Cash

Flow. Because this CMS will represent an investment in fixed assets, explain whether this decision will

change Operating Cash Flow of Snack Box.

Section B: Evaluate the Following Investment Criteria
Review Chapter 13 of our required textbook before completing this task. Your responses should refer to the

output for the various criteria that has been provided in the question.

Evaluation of Alternatives

• Managers generally understand that capital budgeting decision rules complement each other when used

together. Apply two decision criteria listed here (NPV, PB, DPB, IRR) to determine whether Snack Box

should accept or reject this project.

• Review pp. 279-282, 346, 455 and 399-400 of our required text. Explain the limitations of the criteria

(NPV, PB, DPB, IRR) chosen to evaluate the acceptability of this CMS.

References and Sources:
Adamson, A. (2015). How To Make Branded Experiences Rock And Then Go Viral. Forbes.

Author n.d. (2019). Coffee and Snack Shops in the U.S. Ibis World.

Nelson, S. (2019). Taking a break from booze? Try a mocktail at one of these 14 Chicago spots. Chicago Tribune.

Milestone 2 Investing in Capacity Rubric
Criteria Exemplary Satisfactory Minimally Responsive Unacceptable Weight

Decision to

acquire this CMS

– Weighted

Average Cost of

Capital (WACC)

Student explains why only some
component costs of the firm are
included when computing
financing costs for this project,
concentrating on a choice
between a project/divisional cost
of capital versus a firm-wide cost
of capital approach.

Student accounts for risk and
importance of opportunity costs
using rich detail.

Focus is given to building the
foundation for an investment
recommendation.

Student explains why only some
component costs of the firm are
included when computing financing
costs for this project, concentrating
on a choice between a
project/divisional cost of capital
versus a firm-wide cost of capital
approach.

Student Accounts for risk and the
importance of opportunity costs.

Focus is given to building the
foundation for an investment
recommendation, however more
details are needed to fill in
important gaps.

Information about why only some
component costs of the firm are
included when computing financing
costs for this project is briefly
described, with critical issues
remain vague or are missing.

More information is needed
regarding the choice between
project/divisional cost of capital
versus a firm-wide cost of capital
approaches and/or student does
not account for risk and
importance of opportunity costs.

Enough focus is not given to
building the foundation for an
investment recommendation.

Information regarding component
costs of the firm is not included
when computing financing costs for
this project. Critical issues remain
vague or are missing

Details are insufficient or focus is
not given to the choice between
project/divisional cost of capital
versus a firm-wide cost of capital
approaches.

No focus is given to building the
foundation for an investment
recommendation.

Score 30 24 21 0 30

Decision to acquire
this CMS – Cash
Flow Estimation
(Substitutes and
Complements)

A decision to acquire this CMS
using Cash Flow Estimation is
analyzed critically using multiple
perspectives, in detail and with
evidence.

Focus is given to effect on cash
flow of both substitutes and
complements on cash flow.

Supporting details and evidence
to justify claims is relevant,
accurate, and specific to the
claims.

A decision to acquire this CMS
using Cash Flow Estimation is
analyzed critically using multiple
perspectives, in detail and with
evidence.

Focus is given to effect on cash
flow of both substitutes and
complements on cash flow with
minor details missing.

These claims are supported with
evidence and reasons, with minor
details missing.

Only a single perspective is

presented and discussed detail and

with evidence regarding a decision

to acquire this CMS using Cash

Flow Estimation

Focus is given to effect on cash
flow of both substitutes and
complements on cash flow with
major details missing.

Minimal to no evidence are
provided to support claims.

A decision to acquire this CMS
using Cash Flow Estimation s not
discussed in detail and with
evidence.

Focus is not given to effect on cash
flow of both substitutes and
complements on cash flow with
major details missing.

Issues or items discussed are
vague, inappropriate, and/or
inaccurate terms.

Score 20 16 14 0 20

Decision to acquire
this CMS – Effect of
Fixed Assets

The effect of Fixed Assets on
Operating Cash Flow is analyzed
critically using multiple

The effect of Fixed Assets on
Operating Cash Flow is analyzed
critically using multiple
perspectives.

A single perspective is presented
and discussed in detail and with
evidence regarding the effect of

The effect of Fixed Assets on
Operating Cash Flow is not
discussed in detail and/or with
evidence

Criteria Exemplary Satisfactory Minimally Responsive Unacceptable Weight

(Operating Cash
Flow)

perspectives, in detail and with
evidence.

Acquisition of Fixed Assets is
correctly categorized in terms of
its effect on the Statement of
Cash Flows.

Focus is given to reasons for and
effects on changes in operating
cash flow, with consideration of:
initial effect, depreciation effects,
and expected longer term effects
due to the assets’ net
contribution to cash flow over
time.

Claim and or reasons for and
effects on changes in operating
cash flow are accurate.

Supporting detail and evidence
regarding reasons for and effects
on changes in operating cash
flow is included to justify claims
as relevant, accurate, and specific
to the claims. to support claims.

Acquisition of Fixed Assets is
categorized in terms of its effect on
the Statement of Cash Flows, with
minor errors.

Focus is given to reasons for and
effects on changes in operating
cash flow, with consideration of:
initial effect, depreciation effects,
and expected longer term effects
due to the assets’ net contribution
to cash flow over time.

Minor details are missing.

Claims and/or reasons for and
effects on changes in operating
cash flow are accurate.

Claims and/or reasons for and
effects on changes in operating
cash flow are supported.

Fixed Assets on Operating Cash
Flow.

Acquisition of Fixed Assets is not
categorized or incorrectly
categorized in terms of its effect on
the Statement of Cash Flows.

Focus is not given to reasons for
and effects on changes in operating
cash flow, with consideration of:
initial effect, depreciation effects,
and expected longer term effects
due to the assets’ net contribution
to cash flow over time.

Minor details are missing.

Claims and/or reasons for and
effects on changes in operating
cash flow are addressed and are
mostly accurate.

Evidence of minor misconceptions
is present

Acquisition of Fixed Assets is not
categorized or incorrectly
categorized in terms of its effect on
the Statement of Cash Flows.

Focus is given to reasons for and
effects on changes in operating
cash flow, with consideration of:
initial effect, depreciation effects,
and expected longer term effects
due to the assets’ net contribution
to cash flow over time.

Claims and/or reasons for and
effects on changes in operating
cash flow are inaccurate, not
discussed, or not supported.

Evidence of major misconceptions
is present.

Score 20 16 14 0 20

Investment Criteria
– Application of
Investment
Decision

Two Investment Decision
Criteria are described and

analyzed in detail.

Proposed Investment
Recommendation is richly
supported with clear, thorough,
appropriate, and evidence-based
explanations and justifications
relevant to Investment Decision
Criteria described and analyzed.

Two Investment Decision
Criteria are described and

analyzed.

Proposed Investment
Recommendation is supported with
clear, thorough, and appropriate
explanations and justifications
relevant to Investment Decision
Criteria described and analyzed.

The proposed Recommendation is

inaccurate or not relevant and

specific to an analysis of

Investment Decision Criteria.

Proposed Investment
Recommendation is supported with
clear, thorough, and appropriate
explanations and justifications
relevant to Investment Decision
Criteria described and analyzed.

No proposed Recommendation is
provided using Investment Decision
Criteria.

Investment Decision
Criteria not described and analyzed

or are not described and analyzed

in detail.

Decision rules, if analyzed, are not

used to justify acceptance given

two or more of the following: NPV,

Criteria Exemplary Satisfactory Minimally Responsive Unacceptable Weight

Evidence is offered to

demonstrate that decision rules

analyzed justify acceptance given

two or more of the following:

NPV, project risk in relation to

risk level required by the firm,

project PB and DPB fall within

firm’s required limits, or

circumstances dictate use of a PB

period to accommodate other

circumstances.

Supporting detail and evidence to
justify claims is relevant,
accurate, and specific to the
claims.

Decision rules are analyzed to

justify acceptance given two or

more of the following: NPV, project

risk in relation to risk level required

by the firm, project PB and DPB fall

within firm’s required limits, or

circumstances dictate use of a PB

period to accommodate other

circumstances.

Minor details are missing or
arguments could be better
detailed, substantiated and
supported.

Decision rules are analyzed to

justify acceptance given two or

more of the following: NPV, project

risk in relation to risk level required

by the firm, project PB and DPB fall

within firm’s required limits, or

circumstances dictate use of a PB

period to accommodate other

circumstances.

Major details are missing and

arguments are not sufficiently

detailed, substantiated and

supported.

Proposed justifications are vaguely
supported, or not necessarily
relevant to use of investment
Decision Rules to justify this
Investment Decision.

project risk in relation to risk level

required by the firm, project PB

and DPB fall within firm’s required

limits, or

circumstances dictate use of a PB

period to accommodate other

circumstances.

Major details are missing and

arguments are not sufficiently

detailed, substantiated and

supported and/or do not use

investment Decision Rules to justify

this Investment Decision

Score 10 8 7 0 10

Investment Criteria

– Limitations of

Investment

Decision Criteria

Limitations of Investment
Decision Rules to evaluate an
investment decision are analyzed
critically using multiple
perspectives in detail and with
evidence.

Focus is given to limitations of
capital budgeting techniques.

Supporting detail and evidence to
justify claims is relevant,
accurate, and specific to the
claims.

Limitations of Investment Decision
Rules to evaluate an investment
decision are analyzed critically
using multiple perspectives in
detail.

Focus is given to limitations of
capital budgeting techniques.

Claims are generally supported
with evidence and reasons, with
minor details missing.

Limitations of Investment Decision
Rules to evaluate an investment
decision are analyzed. Only a single
perspective is presented and
discussed detail.

Insufficient focus is given to
limitations of capital budgeting
techniques.

Minimal evidence is provided to
support claims and/or evidence is
vague, inappropriate, or
inaccurate.

Limitations of Investment Decision
Rules to evaluate an investment
decision are not discussed in detail
and with evidence.

Focus is not given to limitations of
capital budgeting techniques.

Evidence is not provided or is
vague, inappropriate, or
inaccurate.

Minimal to no evidence is provided
to support claims and evidence
given is vague, inappropriate, or
inaccurate.

Score 20 16 14 0 20

TOTAL 100

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