Cranfield Case Essay

1242 words - 5 pages

1. Incremental cash flows are ultimately the relevant cash flows to be used in project analysis. It is the difference between the cash flows the firm will have if it implements the project, and the cash flows the firm will have if it rejects the project. Although they are a cash expense, interest expenses are not included in project cash flows. We discount a projects cash flows by using its weighted average cost of capital (WACC), which already includes the cost of debt. Therefore, we do not include interest expenses in cash flows because it would essentially be counting them twice.

2. The $150,000 test marketing cost should not be included in the analysis because it is a sunk cost. A sunk cost is an outlay related to the project that was incurred in the past and cannot be recovered in the future. It has already been paid for and does not qualify as an incremental cost, thus making it irrelevant for the analysis.

3. The offer from Cranberry Association to lease the space for $25,000/year over 20 years can be incorporated in as an opportunity cost.
Opportunity costs relate to assets that the firm already owns. Cranfield is using an unused space in the factory that they own for this new project. They are saving an X amount of dollars by already having that space available to them at no extra cost. However, the opportunity to lease for that $25,000/year over the next 20 years acts as an opportunity cost in this case. If the project is rejected, Cranfield could receive that money. If they accecpt the project, it acts as the opportunity cost because it is cash they could have had if they did not use the space for the project. Therefore, $500,000 (25,000*20) would have to be charged to the new project, and failing to do so would result in a false calculation of the projects NPV.

4. If Cranfield does not have the opportunity to lease the space then the space is indeed free and costless, there is no opportunity cost involved anymore. There is no type of cash that Cranfield would be missing out on. However, the space may not technically be free or costless as there could be some maintenance and utility expenses that Cranfield is incurring from the space. Not using the space could incur these expenses further without getting any sort of profit back from it. None of this is mentioned in the case study, so on that basis I will assume that it is free and costless as mentioned earlier.

5. The cannibalization of the profits of regular cranapple sales must be included in the analysis. This an example of a negative within-firm externality and it gets charged as an expense because it is technically lost cash flows. Management of Cranfield would have to use careful thinking and good judgement when analyzing this negative externality. If they choose not to make the lite product because of the cannibalization, then it opens the door for another firm to create the product and steal sales. The textbook sites IBM’s decision in the 1970’s to shift away...

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