QUESTIONS

1. Calculate the initial outlay of introducing the new product, liquid nitrogen ice cream to Christchurch Snowballs. (2 Marks)

2. Calculate the periodic total cash flows for year 1 to year 4 of the LNC project. (11 Marks)

3. Use Excel functions to calculate NPV and IRR of the project. Also calculate Present value index.

Would this introduction of new product add wealth to Ms. Valentine? (2 Marks)

4. Assume that the rental sector for commercial property in Philipstown area is in a strong boom, at what rate of rent (per month) would Ms. Valentine should be indifferent between introducing liquid nitrogen ice cream and renting out the unused space to other people altogether. (2 Marks)

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5. Assume you are hired by Ms. Valentine as her consultant. Prepare an executive summary (about four (to five) pages double spaced) that effectively communicate to her:

1) How the introduction of liquid nitrogen ice cream will affect the value of Christchurch Snowballs and thus her own wealth, based on the above calculations/figures;

2) Additional three points/issues based on your views that should be considered beyond the available information given in this case (e.g. anything missing from a good and thorough analysis, unrealistic assumptions, and others). (3 Marks)

Part A: Capital budgeting (20 marks)

Christchurch Snowballs

Ms. Minnie Valentine moved from Cardiff UK to Christchurch New Zealand in 2015 with her extensive experience in ice cream business to open a home-made Gelato-style ice cream parlor (e.g. the word geleto in Italian means ice cream) named Christchurch Snowballs in Westfield Riccarton (the biggest shopping mall in Christchurch). It was the first of its kind and was successful in building its customer base (or even fan base) thanks to the unique flavor and texture of its products. As the sole owner of Christchurch Snowballs, Ms. Valentine fully enjoyed the abnormal profits during the first few years of the business when there was high profit margin and no competition (in the local specialty ice cream market) in the city. Starting in 2020, however, a few other in-house specialty ice cream parlors have started their businesses in the same city while also locating in the same mall. As a keen businesswoman, Ms. Valentine knew she needed to make a move, and fast. Coming from Cardiff herself, Ms. Valentine has had her eyes on what has been popular in her hometown - the liquid nitrogen ice cream (LNC). The three main advantages of liquid nitrogen ice cream are: 1) ice cream can be made faster due to lower temperature than other ways of making ice creams; 2) smoother texture as there will be less developing of pesky ice crystals when ice cream freezes relatively slowly; and 3) better showmanship as customers can see the display of ice cream making right in front of them.

The introduction of liquid nitrogen ice cream will require a new setup of the production line as the processes are somewhat different from the current one, which is already running at its 90% capacity. The new LNC facilities will be set up in an unused empty commercial space Ms. Valentine owns. It is located in Philipstown, a fast-growing inner small suburb Christchurch. A new machine with an estimated cost of $500,000 will be purchased. It will cost another $20,000 to ship over the machine from the UK while $10,000 will be expenses to have it installed (by UK experts). These additional initial outlays of $30,000 cannot be expensed to deduct tax right away but are allowed to be put into the initial cost in investments (e.g. will be expensed through annual depreciation expenses on the machine through its life). In addition, Christchurch Snowballs inventories (e.g. milk and other ingredients) that are related to LNC will increase by $10,000 since the very beginning (could be several months in reality but just for simplification). The increase in inventory related to the LNC product is projected to grow about 5% each year. All other current assets of the company will not be affected by the introduction of liquid nitrogen ice cream. The new machine has a remaining economic life of 4 years of which the straight-line method of depreciation will be used. For accounting purpose, the salvage value is projected as zero at the end of the fourth year. However, Ms. Valentine has an

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agreement with other established business in Wellington to sell that machine for $60,000 at that point in time (e.g. four years from now).

The section of the facility where the production of LNC will take place accounts for 70% of the whole Philipstown facility. This facility has been unused since Ms. Valentine bought it in early 2016. The original plan was to pursue another business that would be a partnership with her now ex-husband. The facility was rather deserted since the couple separated in late 2016 (100% owned by Ms. Valentine and thus Snowballs after the divorce). Consequently, it had suffered lack of maintenance that caused safety/hygeine concerns. In fact, in an attempt to turn it around for commercial rental, Ms. Valentine had incurred the expense of $60,000 to sort this problem out and get the space ready for commercial use. Such expense will be actually paid about the time when the new project (LNC production) begins. Nevertheless, after such problem was resolved (a few months ago), most recently, another smaller-scaled local confectionary company just offered to rent this Philipstown facility for $2,500 per month, before taxes (rental income assumed received at the end of the year as a lump sum rent and there is no other cost to Christchurch Snowballs involved with renting out this space. Rent income is taxable and assumed the same as business tax rate at 28%).

Based on estimated figures from Ms. Valentines experience, the new liquid nitrogen ice cream will generate $ 600,000 in annual revenues for the next four years. Related fixed and variable costs (together) are estimated as 58% of revenues figures. This comes with the note that the introduction of LNC will decrease the sales of current gelato Christchurch Snowballs ice cream by $100,000 per year (e.g. Christchurch Snowballs customers can travel to Philipstown in just 10 minutes). The production costs of existing gelato ice cream are 72% of revenue figures. The appropriate cost of capital for Christchurch Snowballs is 12 % (per year). Lets assume the business tax rate of 28% (and applied to all kinds of income to the company for simplicity