Indian River Citrus Company

Indian River Citrus Company is a leading producer of fresh, frozen, and made-from-concentrate citrus drinks. The firm was founded in 1929 by Matthew Stewart, a navy veteran who settled in Miami after World War I and began selling real estate. Since real estate sales were booming, Stewarts fortunes soared. His investment philosophy, which he proudly displayed behind his desk, was Buy land. They arent making any more of it. He practiced what he preached, but instead of investing in residential property, which he knew was grossly overvalued, he invested most of his sales commissions in citrus land located in Floridas Indian River County. Originally, Stewart sold his oranges, lemons, and grapefruit to wholesalers for distribution to grocery stores. However, in 1965, when frozen juice sales were causing the industry to boom, he joined with several other growers to form Indian River Citrus Company, which processed its own juices. Today, it Indian River Citrus, Florida Sun, and Citrus Gold brands are sold throughout the United States.

Indian Rivers management is currently evaluating a new product-lite orange juice. Studies done by the firms marketing department indicate that many people who like the taste of orange juice will not drink it because of its high calorie count. The new product would cost more, but it would offer consumers something that no other competing orange juice product offers-35 percent less calories. Lili Romero and Brent Gibbs, recent business school graduates who are now working at the firm as financial analysts, must analyze this project, along with two other potential investments, and then present their findings to the companys executive committee.

Production facilities for the lite orange juice product would be set up in an unused section of Indian Rivers main plant. Relatively inexpensive, used machinery with an estimated cost of only $500,000 would be purchased, but shipping costs to move the machinery to Indian Rivers plant would total $20,000, and installation charges would add another $50,000 to the total equipment cost. Further, Indian Rivers inventories (raw materials, work-in-process, and finished goods) would have to be increased by $10,000 at the time of the initial investment. The machinery has a remaining economic life of 4 years, and the company has obtained a special tax ruling that allows it to depreciate the equipment under the MACRS 3-year class. Under current tax law, the depreciation allowances are 0.33, 0.45, 0.15, and 0.07 in Years 1 through 4, respectively. The machinery is expected to have a salvage value of $100,000 after 4 years of use.

The section of the main plant where the lite orange juice production would occur has been unused for several years, and consequently it has suffered some deterioration. Last year, as part of a routine facilities improvement program, Indian River spent $100,000 to rehabilitate that section of the plant. Brent believes that this outlay, which has already been paid and expensed for tax purposes, should be charged to the lite orange juice project. His contention is that if the rehabilitation had not taken place, the firm would have to spend the $100,000 to make the site suitable for the orange juice production line.

Indian Rivers management expects to sell 425,000 16-ounce cartons of the new orange juice product in each of the next 4 years, at a price of $2.00 per carton, of which $1.50 per carton would be needed to cover fixed and variable cash operating costs. Since most of the costs are variable, the fixed and variable cost categories have been combined. Also, note that operating cost changes are a function of the number of units sold rather than unit price, so unit price changes have no effect on operating costs.

In examining the sales figures, Lili Romero noted a short memo from Indian Rivers sales manager which expressed concern that the lite orange juice project would cut into the firms sales of regular orange juice--this type of effect is called cannibalization. Specifically, the sales manager estimated that regular orange juice sales would fall by 5 percent if lite orange juice were introduced. Lili then talked to both the sales and production managers and concluded that the new project would probably lower the firms regular orange sales by $40,000 per year, but, at the same time, it would also reduce regular orange juice production costs by $20,000 per year, all on a pre-tax basis. Indian Rivers federal-plus-state rate is 40 percent, and its overall cost of capital is 10 percent.

Lili and Brent were asked to analyze this new project, along with two other projects, and then to present their findings in the Indian Rivers executive committee. The information about the other two projects is given below.

The second capital budgeting decision which Lili and Brent were asked to analyze involves choosing between two mutually exclusive projects, S and L, whose cash flows are set forth as follows:

Expected Net Cash Flow

Year	Project S	Project L
0	($100,000)	($100,000)
1	60,000	33,500
2	60,000	33,500
3	--	33,500
4	--	33,500

Both of these projects are in Indian Rivers main line of business, orange juice, and the investment which is chosen is expected to be repeated indefinitely into the future. Also, each project is of average risk, hence each is assigned the 10 percent corporate cost of capital. Which project should be chosen, S or L? Why?

The third project to be considered involves a fleet of delivery trucks with an engineering life of 3 years (that is, each truck will be totally worn out after 3 years). However, if the trucks were taken out of service, or abandoned, prior to the end of 3 years, they would have positive salvage values. Here are the estimated net cash flows for each truck:

Year	Initial Investment and Operating Cash Flow	End-of-Year Net Abandonment Cash Flow
0	($40,000)	$40,000
1	16,800	24,800
2	16,000	16,000
3	14,000	0

Should the trucks be operated for the full 3 years or should we abandon them earlier. The relevant cost capital is again 10 percent.

Questions

Part 1: Problem Identification

Part 2: Data Analysis

e.g incremental cash flow

opportunity cost

Part 3: Generation of Alternative Solutions

Part 4: Evaluation of Alternative Solutions