PART II$.$

Alternative Investment Criteria Problem

Nutrisnax Corporation

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Problem $1$: "SURUCHI" versus "GROFAST"

$1.$ THE BACKGROUND.

Nutrisnax Corporation is a non$-$profit organization dedicated to providing nutritious food to children in the City of Miniland. In the last Annual General Meeting, some members suggested that a worthwhile activity for the Corporation would be to set up low$-$cost kitchens where nutritious ready$-$to$-$eat children's foods could be prepared and sold regularly. Along with the foods, the Corporation could also give the recipes, explaining in very simple steps how the particular food item was prepared. These recipes will be well$-$illustrated, and easy to comprehend. This was considered to be an excellent way of providing children with healthy foods, and at the same time, educating parents on how to cook healthy meals. Mr$.$ Elixus, the Chairman of the Corporation, has enormous faith in the power of children to shape the future of societies, and is thrilled with the suggestion. He invited detailed proposals and has received two very promising ones.

$2.$ THE FIRST PROPOSAL: "SURUCHI"

Under the first proposal "SURUCHI", Nutrisnax Corporation will operate a kitchen where food will be cooked, and then sold to customers. The operations will last for $9$ years. In order to make the program known to the people, the project envisages a publicity expenditure of $10,000$ LC in the first year of operations. No investments in fixed assets are needed, and by purchasing raw materials and hiring workers, it will be possible to prepare the food items easily and hygienically.

The proposal estimates the revenues from sales of nutritious ready$-$to$-$eat foods in the first year to be $12,210$ LC$.$ It is expected to grow at an annual rate of $9$ per cent. In addition, miscellaneous income will also be generated from sales of consolidated recipe books and select ingredients. This will amount to $3,900$ LC in the first year, with an annual growth rate of $6$ per cent.

The estimated operating costs over the nine years are given in Table A$.$

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$3.$ THE SECOND PROPOSAL: "GROFAST"

Under the second proposal "GROFAST", the operations will last for $7$ years. This proposal involves undertaking a more intensive publicity campaign on which an expenditure of $15,000$ LC will be incurred in the first year of operations. Similar to SURUCHI, this proposal also entails no investments in fixed assets. Revenues from the sale of food items are estimated at $10,356$ LC in the first year of operations. These revenues are expected to grow at an annual rate of $15$ per cent. In addition, miscellaneous income in year one is $2,300$ LC$,$ with an expected annual growth rate of $8$ per cent.

Table B shows the projected operating expenses over the life of the project.

$4.$ THE EVALUATION EXERCISE.

At the meeting of the Board of Directors, Mr$.$ Smart argues strongly in favor of SURUCHI on the grounds that it means a smaller investment expenditure on publicity, only two$-$thirds the GROFAST publicity budget, and at the same time, lasts three years longer. Both these indicate that the benefits from SURUCHI are clearly more than the benefits from GROFAST. Mrs$.$ Gulliver supports this viewpoint, and argues that she has figures to back up her claims. She insists that the internal rate of return from SURUCHI is greater than the internal rate of return generated by GROFAST. She is confident that her calculations are accurate, and are based on detailed cash flow statements for each proposal.

Opposing the views expressed by Mr$.$ Smart and Mrs$.$ Gulliver are two other members of the Board, Mrs$.$ Cash and Mr$.$ Count. They argue that this is no way to evaluate the two proposals. They have used the net present value criterion and find GROFAST to be a far more attractive proposition than SURUCHI.

Note: These projects cannot be repeated so there is no need to adjust for the different lengths of life.

$5.$ THE ASSIGNMENT

a$.$ Construct the cash flow statement for the two proposals, and compute the IRR for the two proposals. Are the assertions of Mr$.$ Smart and Mrs$.$ Gulliver regarding the IRR correct?

b$.$ Using a discount rate of $6$ per cent per annum, compute the NPV for the two proposals. Are the assertions of Mrs$.$ Cash and Mr$.$ Count regarding NPV correct?

c$.$ If you were to advise the Corporation, which alternative would you recommend? Briefly justify your answer.