Heavenly Foods Corporation Case Study
By Desiree Healy
Incremental cash flow is defined as “the additional operating cash flow that an organization receives from taking on a new project. A positive incremental cash flow means that the company's cash flow will increase with the acceptance of the project.
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If the project is financed in part by debt, the interest expense should not be included in the cash flow statement because the cost of debt is already embedded in the cost of capital. The project’s cost of capital is the rate of return necessary to satisfy all of the firm’s investors. We discount a project’s cash flows by its risk- adjusted cost of capital, which is a weighted average (WACC) of the cost of debts, preferred stock, and common equity, adjusted for the project’s risk and debt capacity.
The $262,500 test marketing cost should not be included in the capital budget analysis because it is a sunk cost. Sunk Costs are defined as an outlay related to the project that was incurred in the past and cannot be recovered in the future regardless of whether or not the project is accepted. Therefore, sunk costs are not incremental costs and are not relevant in a capital budgeting analysis.
If Heavenly Foods does not have an opportunity to lease the space, it is not free or costless to the lite product project. Instead it is an opportunity cost of $43,750 that must get charged to the new project and failing to do so would cause the new project’s calculated NPV to be too high.
Yes the erosion of profits should be charged to the High Energy Lite product due to cannibalization, a negative within firm externality where the new business eats into the profits of the existing business. Therefore the new products incremental cash flow must be reduced by the amount of the cash flow lost to the previous product....