200426 Coffee Manufacturing Company: Case Study Assessment Answer
Owen, Edward, Charles and Daniel inherited a small family business from their parent’s John and Mary jones in 2013 and changed its name from jones and sons to jones brothers marble works (JBMW). The business produces high-quality natural stone tiles from limestone, marble and travertine and is located in Brisbane. Soon the JBMW has expanded and is now located on one of two adjoining blocks owned by the business. The other block remains vacant. Owen, the major shareholder (40%) and Managing Director, believes that JBMW to diversify into other products. He said it was time they made use of vacant land. Edward and Charles shared the same view however Daniel, the Accountant was not confident about the expansion and preferred the alternative of selling the vacant land. Owen is of the view that now was not the time to sell as land prices were rising in Brisbane and were projected to double in 10 years time according to market forecasts.
Edward is approached by a Hotel Chain to supply material for renovation and also interior work. Edward finds it a good opportunity to diversify in the interior product lines. The gets a market report from a consultancy firm for $75,000 and gets the project cash flows. On a recent visit to Italy Edward also saw beautiful garden pots in travertine and marble which he believed would add value to their external range. Production of these pots were added as an afterthought to the external range after the market report was completed.
Thus JBMW has 3 options:
- Sell the land now for $350,000
- Keep the land maintain it and sell it for $700,000 after 10 years
- Expand internal and external business lines on the land
However to take an informed decision the capital budgeting is done and Daniel is asked to prepare the detailed project evaluation report using the NPV, IRR and the payback period.
- The real rate of return is taken as 20%
- The marketing report cost of $75,000 is not considered as it is the sunk cost
The results of the project evaluation are as follows:
- Net worth is $350,000 if the land is sold now
- If the land is kept for 10 years and sold after 10 years, the business will have the cost of maintenance annually and the NPV will be -$25,113 (Negative)
- If the expansion is done:
The NPV of the project of expansion to the internal line as well as external lines is $145,276. The NPV is positive.
The IRR of the project is 33%
The payback period is 3.38 Years
It is recommended that the business should sell the land block now for $350,000. This will result in direct addition to the net worth of the business.
If the business keeps the land for 10 years it will have to maintain the land and hence it result in reduction in net worth after 10 years.
If the business expands the new internal and external range. The NPV is $ 145,276. This will be the increase in the net worth of the business in 10 years and the business can sell the land for $700,000 after 10 years.
The present value of land sold for $700,000 after 10 years = $113,074
The total present worth is = $258,350 (145,276+113,074) which is less than $350,000
Thus the highest net worth is if the land is sold now for $350,000