Corporate Finance Report: Capital Budgeting Analysis for CMC

This report presents a comprehensive analysis of a capital budgeting project for the Coffee Manufacturing Company (CMC). It addresses the problem of deciding on the financial feasibility of developing an integrated coffee brewer and grinder. The report employs capital budgeting techniques, including Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period (PBP), to evaluate the project's viability under normal, optimistic, and pessimistic scenarios. Key findings reveal that, based on the provided data, the project is not financially viable, except in the optimistic scenario. The report includes a sensitivity analysis, examining the impact of changes in sales volume and selling price. It also considers other factors, such as social trends, political factors, and corporate culture, that might influence the decision. The conclusion recommends rejecting the project to maximize the company's return on investment and profitability. The report provides detailed cash flow analysis and discusses the limitations and other factors impacting the capital investment decision.

Running head: CORPORATE FINANCE
Corporate Finance
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

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Table of Contents
Cash flows for the project and capital budgeting analysis:.............................................................2
Executive Summary:........................................................................................................................4
i. Definition of the problem:........................................................................................................4
ii. Objectives:...............................................................................................................................5
iii. Methods:.................................................................................................................................5
iv. Key findings:..........................................................................................................................5
v. Conclusion:..............................................................................................................................7
vi. Recommendations:.................................................................................................................8
4. Other factors for consideration:...................................................................................................8
References:....................................................................................................................................11

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Cash flows for the project and capital budgeting analysis:
Normal scenario:
Optimistic scenario:

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Pessimistic scenario:

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Executive Summary:
i. Definition of the problem:
Coffee Manufacturing Company (CMC) is confronted with a decision on developing an
integrated coffee brewer and grinder for assuring unique freshness of the brew; however,
problems have taken place with the frothing or milk warming operation.

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ii. Objectives:
The goal of the report and the entire exercise of capital budgeting conducted is to resolve
the present issue. The main reason of preparing the report is to provide an appraisal of the
concerned project to the Board of Directions and CEO of CMC regarding its financial feasibility.
iii. Methods:
The project appraisal would be conducted by using capital budgeting techniques
constituting of net present value (NPV), internal rate of return (IRR) and payback period (PBP).
The sensitivity analysis of the proposed project is conducted by increasing 10% of sales volume
and selling price in the optimistic scenario and by decreasing 10% of sales volume and selling
price in the pessimistic scenario, while all other variables are kept constant. Critical discussion of
the other factors that might have impact on the proposal has been discussed as well. The
recommendations have been made by considering the key findings based on the capital
budgeting outcomes and sensitivity analysis.
iv. Key findings:
The cash flow assumptions have been made for including all incremental cash inflows
and outflows from the project. The organisation has incurred $500,000 for test marketing, which
has been completed in 2018. This cost is not taken into consideration owing to the fact that it is
sunk cost, as it has been incurred before the initiation of the project (Andor, Mohanty and Toth
2015). In addition, the interest expense of 7% on loan undertaken is not considered in this project
as well, as it would result in double counting of debt in the opportunity cost of capital.
The key findings have been based on the appraisal of the concerned project by using
certain capital budgeting techniques that mainly include Net Present Value (NPV), Internal Rate

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of Return (IRR) and Payback Period (in PBP). The results of these techniques for the project are
represented in the form of a table as follows:
Particulars Normal Scenario Optimistic Scenario Pessimistic Scenario
Net Present Value -$ 201,306 $ 1,190,746 -$ 1,460,782
Internal Rate of
Return 10.88% 25.07% -3.29%
Payback Period 7.45 4.58 NA
Table 1: Values of capital budgeting techniques for the concerned project of Coffee
Manufacturing Company
(Source: As created by author)
The net present value of a project assists in ascertaining the profitability from the same
by discounting the cash flows to the future value (Batra and Verma 2017). When the NPV of any
project is positive and higher, it implies that the organisation would be able to generate
considerable amount of profit from the concerned project or investment. In this case, based on
the provided information, inflation rate of 2% is not taken into consideration and there is no
consideration of lease income made, since it has not been provided yet (Bierman Jr and Smidt
2014). From the above table, it could be witnessed that the NPV of the concerned project for the
normal scenario is computed as ($201,306), while for the optimistic and pessimistic scenarios,
the NPVs are found to be $1,190,746 and ($1,460,782). This clearly implies towards the fact that
except for optimistic scenario, the NPV of the project would be positive, while other factors
remain constant. Thus, based on NPV, the project could not be undertaken by CMC.

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Internal rate of return helps in finding out return on investment of a particular project by
making the NPV of the project equal to zero (Chittenden and Derregia 2015). This technique is
deemed to be favourable for an organisation when it is more than the opportunity cost of capital
and it is not favourable when it goes below the opportunity cost of capital. For the proposed
project, the IRR is computed as 10.88% for the normal scenario, 25.07% for the optimistic
scenario and -3.29% for the pessimistic scenario. On the other hand, the opportunity cost of
capital of the project is identified to be 13%. Thus, it could be said that except in the optimistic
scenario, the internal rate of return is lower than the opportunity cost of capital; thereby,
denoting the non-viability of the concerned project.
Payback period denotes the amount of time needed for an organisation to gain its initial
investment back. When the payback period is lower compared to the useful life of the project, it
is feasible to undertake the project and vice-versa (Daunfeldt and Hartwig 2014). In this case, the
payback period for the normal scenario and optimistic scenario are computed to be 7.45 years,
4.58 years and 7.21 years respectively and there is no payback for the optimistic scenario, while
the useful life of the project is 10 years. Hence, the payback period in the normal and optimistic
scenarios is lower than the useful life of the project. However, for declining sales, CMC might
not be able to recover initial investment and hence, the project might fetch loss.
v. Conclusion:
From the above analysis, it is evident that the project is not expected to yield significant
benefits to CMC, since it would suffer significant amount of losses, as evident from the
application of capital budgeting techniques. Moreover, it is identified that the project is highly
sensitive, as losses would result in negative outcomes for the organisation.

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vi. Recommendations:
By considering all the above-discussed aspects, it could be stated that the capital
budgeting techniques used have revealed negative outcomes for Coffee Manufacturing
Company. In addition, with the fall in sales volume and selling price per unit, the project would
yield significant losses for the organisation. Hence, CMC is advised to reject the project so that it
could maximise its overall return on investment and profitability position in the market.
4. Other factors for consideration:
There are certain qualitative factors that could be taken into consideration before CMC
decides to undertake the project and they are elucidated briefly as follows:
Social trends:
With the passage of time, there might be change in the viewpoint of the society. In case;
the consumers of CMC prefer more green products in future, it might not be wise to build a
factory where there would be spewing of brown smoke from the big chimneys (De Andrés, De
Fuente and San Martín 2015). The social trends have impact on the number of hours the staffs
would like to work in future and the kind of jobs they would like for a provided salary having
impact on the manufacturing facilities.
Political factors:
The magazines and business papers on certain occasions read like political publications
and they analyse every move of the government, since political decisions have considerable
influence on the business operations of an organisation (Nurullah and Kengatharan 2015). The
ways through which the government could tax imports and exports is the single largest factor

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when it comes to ascertain the location of any factory. The methods through which numerical
inputs like minimum wages and tax rates would shape up rely in qualitative factors depending on
political decisions.
Corporate culture:
It has been observed that a sensible decision depending on hard figures do not provide the
desired outcome, as it is not compatible with the corporate culture. The speed with which it is
possible for an organisation to act, the efficiency of the staffs and the way through which the
organisation is involved in dealing with failure are parts of corporate culture having impact on
capital budgeting decisions (Rossi 2014). Some organisations progress by providing quality
following premium pricing strategy, since they deploy meticulous and experienced individuals
taking pride in their work. This type of business needs to consider before investing in any factory
designed for manufacturing increased numbers of cheaper items (Rossi 2015).
There are other factors that have impact on the capital investment decision of an
organisation and they are demonstrated briefly as follows:
 Flexibility in manufacturing processes
 Quality of the product
 Morale of the staffs
 Manufacturing productivity
 Manufacturing control (Schlegel, Frank and Britzelmaier 2016)
 Implications for operations and production including any disruption or change to the
current set-up
 Customer services

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References:
Andor, G., Mohanty, S.K. and Toth, T., 2015. Capital budgeting practices: A survey of Central
and Eastern European firms. Emerging Markets Review, 23, pp.148-172.
Batra, R. and Verma, S., 2017. Capital budgeting practices in Indian companies. IIMB
Management Review, 29(1), pp.29-44.
Bierman Jr, H. and Smidt, S., 2014. Advanced capital budgeting: Refinements in the economic
analysis of investment projects. Routledge.
Chittenden, F. and Derregia, M., 2015. Uncertainty, irreversibility and the use of ‘rules of
thumb’in capital budgeting. The British Accounting Review, 47(3), pp.225-236.
Daunfeldt, S.O. and Hartwig, F., 2014. What determines the use of capital budgeting methods?:
Evidence from Swedish listed companies. Journal of Finance and Economics, 2(4), pp.101-112.
De Andrés, P., De Fuente, G. and San Martín, P., 2015. Capital budgeting practices in
Spain. BRQ Business Research Quarterly, 18(1), pp.37-56.
Nurullah, M. and Kengatharan, L., 2015. Capital budgeting practices: evidence from Sri
Lanka. Journal of Advances in Management Research, 12(1), pp.55-82.
Rossi, M., 2014. Capital budgeting in Europe: confronting theory with practice. International
Journal of Managerial and Financial Accounting, 6(4), pp.341-356.
Rossi, M., 2015. The use of capital budgeting techniques: an outlook from Italy. International
Journal of Management Practice, 8(1), pp.43-56.

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Schlegel, D., Frank, F. and Britzelmaier, B., 2016. Investment decisions and capital budgeting
practices in German manufacturing companies. International Journal of Business and
Globalisation, 16(1), pp.66-78.

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Thippayana, P., 2014. Determinants of capital structure in Thailand. Procedia-Social and
Behavioral Sciences, 143, pp.1074-1077.
Wnuk-Pel, T., 2014. The practice and factors determining the selection of capital budgeting
methods–evidence from the field. Procedia-Social and Behavioral Sciences, 156, pp.612-616.