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Grading Criteria
Section A: Explain Components of Project Analysis
1. Weighted Average Cost of Capital (WACC)
Begin your analysis of acquisition by explaining why only some component costs of the firm are included when computing financing costs for this project, concentrating on the choice between a project/divisional cost of capital versus a firm-wide cost of capital approach. (max 400 words) [30 points]

2. Principles for Cash Flow Estimation

Consider one Complement sold within each franchise location and one Substitute establishment. (max 200 words) [20 points]
Because this CMS will represent an investment in fixed assets, explain whether this decision will change Operating Cash Flow (see Example 2.6 on p. 49 of our required text) and Free Cash Flow (see p. 49 of our required text). (max 100 words) [10 points]

Section B: Evaluate
Evaluation of Alternatives

Your evaluation of this potential acquisition requires you to select and apply investment decision rules. In this section, you are to present an evaluation of this acquisition based on an application of the decision rules selected and a summary of benefits and limitations of these capital budgeting techniques. (500 words max) [20 points]
Your evaluation of the acceptability of this CMS requires you to supply a recommendation on the acceptability of investment in this project based on the preceding categories of information. In the concluding section, you are to elaborate on the limitations of the above analysis, including what further sources of information you would like to use to make a more informed decision. (400 words max) [20 points]

Milestone 2: Investing in Capacity

Case
Coffee and snack shops are a popular and growing industry in the United States. It is forecasted that they will

continue to grow at rates faster than general economic growth; in 2019, this market was valued at almost 60

billion dollars (Ibis World, 2019). Desserts and other luxury snack items are sometimes marketed as a branded

“experience,” like high-end specialty snack items. To understand how a product can be sold as an experience,

you might think of “Eloise at the Plaza,” the “American Girl Tea Shop” in New York City, an “Escape Room” or

Murder Mystery Nights. Demand for luxury snack items sold as branded experiences increases with disposable

income, or the income that consumers have left over after necessary costs, like shelter and transportation, are

covered. Luxury snack items addressing food allergies and intolerances are also often sold in unique branded

environments. Lactose-free ice cream is one such product.

Competition in the market for luxury snack items is fierce, and franchisees selling these items frequently see the

establishment of close competitors in nearby locations. The success of one establishment may lead to a

mushrooming of similar establishments nearby.

Snack Box (a fictitious company) allows franchisees to market a set of branded items under conditions governing

the nature of the establishment selling the products. Franchise agreements also dictate behavior of employees

presenting items to the public within franchises. As a parent firm, Snack Box oversees multiple franchised

locations and operators. Brands managed by Snack Box include frozen ices and custards, pretzels, waffles and

crepes, moxtails, and related food items. To ensure uniformity across locations, Snack Box requires that all

employees are similarly trained.

Note: A franchise allows a franchisee access to a firm’s proprietary knowledge, processes, and

trademarks or brands. The franchisee pays the franchisor or parent firm an initial start-up fee plus

annual licensing fees. In addition, franchisees pay the parent firm a percentage of revenue outlined in

each franchising agreement.

Assume you are the owner and Chief Financial Officer of Snack Box. You plan to purchase an “off the shelf”

content management system (CMS, or a software application or set of related programs used to create and

manage digital content). The evaluation of the CMS will meet some business requirements of Snack Box:

• Improve employee training and satisfy client training needs: The CMS includes a library of existing

human resources training, compliance, and professional development courses or modules. Training is

interactive, social, and gamified to provide an incentive to complete the required training. Selected

training systems allow authoring and modification of existing courses to meet the needs of various

franchisees, products, locations, and compliance requirements. The CMS should have the ability to host

multiple differently branded websites for the delivery of training information. You expect to increase the

effectiveness of each location as a result.

• Meet the unique financial needs of the parent firm. The CMS needs to be used across a portfolio of

franchise operations offering specialty food items, including custom brewery products and ciders,

crepes, waffles and breakfast dinners.

Snack Box has reviewed project-specific and firm-wide approaches to determining a weighted average cost of

capital to utilize in valuing this project. It has determined that this project has lower firm-specific risk than other

projects in which the firm is involved. You have developed the following capital budgeting criteria based on

expected project cash flows, as follows:

You have determined that the interest rate (risk) assigned to this project is 11% and the maximum allowable

payback (PB) and discounted payback (DPB) periods for Snack Box are 3 and 3.5 years, respectively. You have

determined that the CMS will increase franchise fees and revenues with normal project cash flows shown as

follows:

Project Cash Flows Chart

Time in Years 0 1 2 3 4 5

Cash Flow $235,000 $65,800 $84,000 $141,000 $122,000 $81,200

Applying Net Present Value (NPV), Payback Period (PB), Discounted Payback Period (DPB), and Internal Rate of

Return (IRR) as capital budgeting decision methods and discounting at a rate of 11%, you have evaluated NPV,

PB, DPB and IRR. You have found that these decision rules call for acceptance or rejection of the project as

follows:

As part of your assignment, you will need to interpret the results for the various capital budgeting criteria that

have been provided below. Specific questions will be provided in the project requirement section that follows.

Payback Period Chart

Time in Years 0 1 2 3 4 5

Cash Flow ($235,000) $65,800 $84,000 $141,000 $122,000 $81,200

Cumulative Cash Flow ($235,000) ($169,200) ($85,200) $55,800 $177,800 $259,000

PB: 2.6 years = = 2 + ($85,200/$141,000)

Net Present Value

Time in Years 0 1 2 3 4 5

Cash Flow ($235,000) $65,800 $84,000 $141,000 $122,000 $81,200

Discount (1+.11)0 (1+.11)1 (1+.11)2 (1+.11)3 (1+.11)4 (1+.11)5

Discounted Cash Flow ($235,000) $59,279 $68,176 $103,098 $80,365 $48,188

NPV $124,106.98  

Internal Rate of Return

Time in Years 0 1 2 3 4 5

Cash Flow ($235,000) $65,800 $84,000 $141,000 $122,000 $81,200

Discount (1+IRR)0 (1+IRR)1 (1+IRR)2 (1+IRR)3 (1+IRR)4 (1+IRR)5

0 = ($235,000) $51,091 $68,176 $103,098 $80,365 $48,188

IRR 28.79%
Project Value using IRR $ 115,918.62

Project Requirements
Your task is to prepare a document to make an effective decision regarding the investment in this software and

related equipment. Your document should focus on the following specific explanations within sections A and B.

Section A
Explain the following elements of the decision to acquire this CMS.

1. Weighted Average Cost of Capital (WACC)
Review Example 11.6 and pp. 374-381, 400, and 424 of our required text for more information on Project and

Divisional Costs of Capital. Why is one component of Weighted Average Cost of Capital (WACC) calculated

differently if project risk differs significantly from risk of existing projects (as in this case), than it is when project

risk does not differ significantly from risk of existing projects?

2. Principles for Cash Flow Estimation
• Review pp. 399-400 of our required text for more information on Substitutes and Complements. For

franchise locations, explain how each of the following two factors may affect Snack Box’s NPV estimates:

o One Complement product or service sold within each franchise location, and

o One Substitute establishment (meaning a competing establishment attracted by the success of

the Snack Box franchise).

• Review Example 2.6 on p. 49 of our required text, plus pp. 401-405 of our required text) and Free Cash

Flow. Because this CMS will represent an investment in fixed assets, explain whether this decision will

change Operating Cash Flow of Snack Box.

Section B: Evaluate the Following Investment Criteria
Review Chapter 13 of our required textbook before completing this task. Your responses should refer to the

output for the various criteria that has been provided in the question.

Evaluation of Alternatives

• Managers generally understand that capital budgeting decision rules complement each other when used

together. Apply two decision criteria listed here (NPV, PB, DPB, IRR) to determine whether Snack Box

should accept or reject this project.

• Review pp. 279-282, 346, 455 and 399-400 of our required text. Explain the limitations of the criteria

(NPV, PB, DPB, IRR) chosen to evaluate the acceptability of this CMS.

References and Sources:
Adamson, A. (2015). How To Make Branded Experiences Rock And Then Go Viral. Forbes.

Author n.d. (2019). Coffee and Snack Shops in the U.S. Ibis World.

Nelson, S. (2019). Taking a break from booze? Try a mocktail at one of these 14 Chicago spots. Chicago Tribune.