Cranfield Inc Case Capital Budgeting

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FRL 440

Cranfield, Inc.

Capital Budgeting

Introduction

Cranfield, Inc. is a company which produces a variety of fresh, frozen and made-from-concentrate cranberry drinks. The firm is interested in exploring the creation of a new product, lite cranapple cocktail. Market tests have been done, but they have requested that our consulting firm work with their employees, Maria Lopez and Robert Walker, to analyze the project and present our findings and recommendations to Cranfield’s executive committee.

Analysis

1. An incremental cash flow is additional cash flow that results directly from taking on an investment in a new project. Incremental cash flows allow a company to determine whether or not it is worth their time and money to invest. A positive incremental cash flow would be a good indicator that the company should move forward with the project. The project’s statement of cash flows should not include the interest expense because it is an irrelevant component of the statement, as are sunk costs related to the R&D of firms. Interest expense is a financing cost, not an operating cost and it is used in the cost of capital. To explain in detail, because we already accounted for the “X” percentage of cost of capital (WACC) to discount the cash flows, adding interest expense will just cause us to deduct capital cost twice.

2. The $150,000 test marketing cost is actually considered to be a sunk cost, not an incremental cash flow. As mentioned in the question above, sunk costs should not be included in the cash flow analysis. Whether or not the test marketing cost is included would not have an effect on the company’s decision to accept or reject the project.

3.  If the Nantucket Cranberry Association made a firm offer to lease the lite juice production site for $25,000 a year for 20 years, then that information would need to be included in the analysis. If the production facility were leased...