Investment Proposals for Orio Coffee House
|General presentation and format (spelling, grammar)||10%|
|Identification of relevant cash flows and summary of cost information||15 %|
|Calculation of Cash flows||45 %|
|Investment criteria calculated||20%|
|Evaluation and Recommendation||10%|
Instructions & Submission
You work as Financial Manager at Orio Coffee House (OCH), known to be best coffee chains & wholesaler of bakery items in Brampton. Chief Executive Officer of Orio Coffee House, Daniel Jackson, has approached you to make a report on assessment investment proposal, whether it is feasible proposal or not
Investment Proposals for Orio Coffee House
Daniel Jackson, CEO of OCH, has approached you to work on investment proposal of buying coffee roaster plant in Mexico
Proposal: Buying coffee roaster plant in Mexico.
Mr. Daniel reminds you to consider only relevant expense and income. “Relevant costs have to be occurring in the future,” he said. “And have to be unique from the status quo. For example, if we choose to buy the roaster plant, it is only the incremental revenue and costs related to the purchase that should be considered. We also need to take into account the opportunity cost associated with the alternatives.”
More details on both of investment proposal is written below. Mr. Daniel wants you to recommend after evaluation, if OCH should invest in the investment proposal or not.
Mr. Daniel wants you to use 7% as the discount rate (i.e., the required return).
Proposal of Investment in Roasted Coffee Plant
Mr. Daniel is considering investing in a coffee plant in Mexico where you can get cheap labor and there are proximal coffee farms that can decrease transportation costs.
The cost of acquisition of the plant is $7Million, which covers roasting equipment that originally cost $14Million when it was purchased 8 years ago. Some of the equipment is obsolete and need to be discarded, so an additional $2Million of equipment has to be purchased. The roaster plant currently has $2Million of available tax shield left, excluding any tax shield related to the equipment to be purchased.
The raw materials and direct labor used for manufacturing these products are 8% and 7% of sales, respectively. The processing costs for roasting are approximately 17% of total sales. All of these costs as a percentage of sales are expected to remain constant over the time horizon. The plant also needs 2 managers with fixed salaries of $50,000 each per year. Insurance cost for the plant and equipment is $40,000 per year.
Additional incremental production overhead costs (property taxes, maintenance, security, etc.) excluding depreciation are estimated as $75000 yearly. Wages are expected to rise with inflation (estimated to be 2%) over the time period, while other fixed costs are expected to remain steady.
Transportation related variable costs (gas, variable overhead, etc.) are estimated to be 12% of revenue, and include transportation of raw materials to the roaster and finished products to the port for delivery to OCH coffeehouses.
The roasted coffee plant is expected to produce 1.1M pounds of coffee for the first two years, with production dipping by 100,000 pounds per year after this due to lower productivity from the deteriorating equipment. Each pound of roasted coffee can be sold at $3.25 per pound (either to retail cafes, franchise cafes, or to wholesale partners), with the price expected to rise with inflation over time. Each pound of coffee can make 30 cups of coffee that can sell at an average retail price of $4.00 per cup. Mr. Daniel has stressed that the profitability of the plant base has to be looked at on a stand-alone basis, i.e., from the sales from the plant to buyers, not from retail cafés to customers.
Mr. Daniel wants to evaluate if project will be profitable after 5 years, as significant reinvestment will be needed after five years to keep the plant operational, so he wants you to evaluate the return on investment in that period using the investment criteria of payback period, NPV, and IRR. The tax rate Mr. Daniel wants you to utilize is 25%.
Requirements – (Investment Proposals for Orio Coffee House)
- Identify which revenues and costs are relevant to your analysis, and which costs are irrelevant. Summarize all the information that will be required for each investment proposal, including describing the proposal and identifying the time horizon proposal evaluation.
- Calculate the after-tax cash flows during the life of the projects.
- Utilizing the after-tax cash flows from question 2, evaluate investment proposal utilizing the following criteria (unless directed otherwise):
- Clearly indicate whether any of the above criteria support the project proposals, and what the company should ultimately decide to do.