Case Scenario -Berber Bread Yousef Tizir, Jr., CEO of Berber Breads Co. (BBC), Inc. offered his closing comments and then disconnected the conference call. The call had been with Costco Wholesalers product development team. Costco wanted BBC to supply the chain with its wholegrain tanort or flatbread. Both parties had put their cards on the tableit was time to make a decision. Today BBC distributes its products in Texas and its 5 neighboring states. The Costco deal was, however, the proverbial game changer. The firm would need to gear up production, and it did not have long. The unsigned contract dictated a staged rollout of BBCs product; the first shipment of flatbread is to arrive at Costco stores in southern states by January 1, 2022. If the products sell well, then other regions would be added. Unfortunately, if the flatbread sells as predicted the current production line would be unable to meet production needs. To thoroughly evaluate the opportunity, BBC has spent $15,000 researching a new production line and the implications of this deal. The finance department has learned that the physical equipment needed to transform the existing bakery line could be purchased for $1.8 million. It would cost another $300,000 to ship and install the equipment. In addition, BBCs staff will need to undergo an intensive training program. This training will cost $10,000. Thus far in year 2021 (Year 0), BBC has sold 12,000 cases of flatbread each month, at an average selling price of $6.50. If the status quo is maintainedslow steady growththe firm expects to grow at an 8% annual rate over the next 4 years and settle at 5% in Year 5. However, sales are expected to change dramatically if BBC agrees to sell through Costcoprojections indicate that next year (Year 1) case sales would be double those predicted without the Costco contract. While unit sales are predicted to shoot upward, Costco has negotiated a lower price, and this means that the average case selling price (average of Costco and existing case price) would drop to $5.25. Then, as more Costco locations are added to the rollout, total annual revenues are projected to increase 50% (year-over-year) in Years 2 and 3, 20% in Year 4, and 10% Year 5. Today (year 0) total variable and fixed operating costs consume about 50% of revenues. It is anticipated that as a percentage of sales, these costs will increase about one percentage point per year over the next five years. But, with the Costco deal, the firm anticipates economies of scale that will reduce total operating costs to about 31% of revenues in Year 1, 33% in Years 2 and 3, and 35% in the last two years of the project. The anticipated increase in sales will lead to an increase in working capital requirements. Prior to beginning production of the Costco products, a one-time increase of $100,000 in its inventory (flour, shortening, etc.) will be necessary. This will be partially offset by an increase in accounts payable of $45,000. The existing bakery line was installed 5 years ago and had an estimated economic life of 10 years. At that time, BBC paid $750,000 to buy the machinery. The machine is depreciated using straight-line depreciation. Today, it is believed that the existing equipment can be sold for $400,000. BBCs chief financial officer has predicted that the new equipment has a five-year economic life. It will also be depreciated using straight-line depreciation. At the time of replacement/renovation it is estimated that the firm could sell the new equipment for about 30 percent of its original installed cost to another wholesale bakery. If it could not be sold, its salvage value is $100,000. BBC is in the 21% marginal tax rate, and the riskiness of this project warrants that is be assigned a 22% cost of capital (AKA, the required rate of return on the project). The firm has unlimited funds to invest and faces no other constraints in its capital budgeting decisions.