Mini$-$Case: Capital Budgeting Processes

AND TECHNIQUES

Durango Cereal Company is considering adding two new kinds of cereal to its product

line$-$one geared toward children and the other toward adults. The company is currently

at full capacity and will have to invest a large sum in machinery and production space.

However, given the nature of cereal production, the investment in machinery will be more

costly for the children's cereal $($Poofy Puffs$)$ than for the adult cereal $($Filling Fiber$).$ The

expected cash flows for the two cereals are:

Management requires a minimum return of $15\%$ in order for the project to be acceptable.

The discount rate for projects of this level of risk is $10\%.$ Management requires projects

with this type of risk to have a minimum payback of $1\mathrm{.}75$ years.

Assuming the projects are independent and ignoring the issue of scale, what should

Durango Cereal Company do$?$ Include calculations for the payback method, the dis$-$

counted payback method, net present value, internal rate of return, and profitability index

in your analysis. Revisit the problem considering the scaling issue. Which project should

the company consider, if any?

Also, include a graph showing the NPV Profile of both alternatives. Finally, calculate the Cross

Over rate and show in graph of NPV profile.