Assignment:
Sophie Morgan, President of Cayuga Cookies, Inc. (CCI), was trying to decide whether to expand
the company by adding a new product line. The proposal seemed likely to be profitable and
adequate funds to finance it could be obtained from outside investors.
CCI had long been regarded as a well-managed company. It had succeeded in keeping its
present product lines up to date and had maintained a small but profitable position in a highly
competitive industry.
The amount of capital presently employed by the company was approximately $4,000,000, and
was expected to remain at this level whether the proposal for the new product line was accepted
or rejected. Net income from existing operations amounted to about $400,000 a year, and
Morgan’s best forecast was that this would continue to be the income from present operations.
Introduction of the new product line would require an immediate investment of $400,000 in
equipment and $250,000 in additional working capital. A further $100,000 in working capital
would be required a year later.
Sales of the new product line would be relatively low during the first year, but would increase
steadily until the sixth year. After that, changing tastes and increased competition would probably
begin to reduce annual sales. After eight years, the product line would probably be withdrawn
from the market. At that time, the company would dispose of the equipment and liquidate the
working capital. The cash value of steps to close the product line at that time would be about
$350,000.
The low initial sales volume, combined with heavy promotional outlays, would lead to heavy
losses in the first two years, and no net income would be reported until the fourth year. The profit
forecasts for the new product line are summarized in Exhibit 1.
Morgan was concerned about the effect this project would have on CCI’s overall reported
profitability over the next three years. On the other hand, “eyeballing” the figures in Exhibit 1 led
Morgan to guess that if the proposal were analyzed using after-tax cash flows discounted at 10
percent, it might well show a positive
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