Indian River Citrus Co

Learning outcomes
Evaluation of Project
Identification of cash flows
Project assessment methods
NPV, IRR, MIRR, Payback

Decision Criteria
Case
Project Launch a new product line Lite
Orange juice

Indian River Citrus Co

Identification of Cash Flows
Year 0 cash flows-Initial Costs
Changes in working capital
Annual operating cash flows
Terminal year cash flows

Common type of cash flow issues

Opportunity cost
Sunk cost
Erosion cost

Impact of inflation on cash flows

Initial & Terminal Year Cash Flow

What is the initial (Year 0) net investment

outlay on this project?
What is terminal year (year 4) expected
non operating cash flow when the project
is terminated
Hint: Use spreadsheet

Common types of cash flows

Sunk costs costs that have accrued in the past

Opportunity costs costs of lost options
Side effects
Positive side effects benefits to other projects
Should the positive side effects be included?
How would you incorporate the positive side effects in your
analysis of cash flows
Negative side effects (erosion) costs to other projects
How do account for erosion?
Changes in net working capital
Financing costs
Taxes

Other issues

Should the amount spent to rehabilitate the

plant be included in the analysis?
How should Cannibalization effect be handled
under different assumptions of expected
competitor actions?
How about the another juice producers
interest in leasing the space that would be
used for lite juice production and the other
divisions plant needs 2 or 3 years hence?
Does the project have any positive side effects
and how should it be accounted

Opportunity Cost

Suppose another juice producer actually made an

offer to lease the lite juice production site for
$25,000 a year for 20 years. How should that
information be incorporated in your analysis?
The relevant cash flow is the annual after-tax
opportunity cost.
A-T opportunity cost = $25,000 (1 T)
If the company does not have the opportunity
to lease the space, does this mean that the
space is free or costless, from the standpoint
of the lite product project?

Erosion Cost

Should the erosion of profit from regular

cranapple sales be charged to the lite
cranapple project?
If Indian River Citrus did not introduce the lite
product and a competing firm would likely do
so, then regular sales would be adversely
affected regardless of whether or not the
project is accepted?
Hint: Look at the spreadsheet and related
class notes

Impact of Inflation on Cash Flows

Project evaluation uses market determined

nominal cost of capital as the discount rate,
whereas sales price and operating cost per
unit are assumed to remain constant
throughout the projects life.
What are the problems with such an analysis
in which the discount rate is in nominal terms,
but the cash flows are measured in current
dollar terms, unadjusted for inflation?
Hint: Look at related class notes and
spreadsheet

Second and third Capital

Budegeting Projects
Show your analysis and answers to your
calculations and clearly state why you
would choose any project.
Hint: For the third project, the economic
life can be defined as the life that
produces the highest NPV

Recommendations
State your overall recommendations for
each of the capital budgeting projects and
the criteria for your recommendations.