Identify which revenues and costs are relevant to your analysis, and which costs are irrelevant.

Instructions & Submission
You work as Financial
Manager at Orio Coffee House (OCH), known to be the best coffee chain & wholesaler
of bakery items in Brampton. Chief Executive Officer of Orio Coffee House, Daniel
Jackson, has approached you to make a report on the assessment investment proposal,
whether it is a feasible proposal or not?
Investment Proposal for Orio Coffee
House

Daniel Jackson, CEO of OCH, has approached you to work on an investment proposal of buying a coffee roaster
plant in Mexico
Proposal: Buying coffee roaster plant in Mexico.
Mr. Daniel reminds you to consider
only relevant expenses 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 investment proposals are written below.
Mr. Daniel wants you to recommend after evaluation if OCH should invest in the
investment proposal or not.
Required Return
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 labour 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 Some of the equipment is obsolete and needs to be discarded, so an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 labour 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. The 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 the 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 the payback period, NPV, and IRR. The tax rate Mr. Daniel wants you to utilize is 25%.

Requirements
1. 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.
2. Calculate the after-tax cash
flows during the life of the projects.
3. Utilizing the after-tax cash
flows from question 2, evaluate investment proposal utilizing the following
criteria (unless directed otherwise):
a. Payback
b. NPV
Clearly indicate whether
any of the above criteria support the project proposals, and what the company should
ultimately decide to do.

Last Completed Projects