Question

Durango Cereal Company is considering adding two new kinds of cereal to its product line – one geared towards children and other towards adults. The company is currently at full capacity and will have to invest 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 : YEAR POOFY PUFFS FILLING FIBER

0 -$ 24,890,000 -$13,500,000

1 12,950,000 7,230,000

2 10,923,000 8,100,000

3 8,231,000 8,629,000

4 7,242,000 5,238,900

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 1.75 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 discounted payback method, net present value, internal rate or return, and profitability index. Include HIRR in your analysis

Answer 1

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