Energy Gel Case Report
With the High Performance Corporation Energy Gel case before us, we recommend to Florence Vivar, chief financial officer of HPC, that the company should not invest in the energy gel project. We came to this conclusion after amending the existing capital budgeting process, and assessing the opinions of Harry Wickler, Mark Leiter, and Frank Nanzen in how to evaluate the project.
The capital budget process in place is to use the payback period and return on invested capital (ROIC) for the project. The payback period criterion is a flawed way to determine the value of the project because it does not take into account cash flows after the required payback period (7 years). For example, if the Energy Gel project had not…show more content…
To project this expense, we used 12 percent of Energy Bar’s general and administrative expense from 2001($12.7 M), for 2001 (Exhibit 1). Then we multiplied the previous years value by 1.08 (8 percent growth) for the next nine years starting in 2002.
We decided that cannibalization was not a cost to consider because the Energy Gel product was in a completely different consumer category than the Energy Bar. Customers using Energy Gel will be consuming the product shortly before, during, or right after strenuous activities, while Energy Bars will continue to be consumed throughout the day at the volume as pre energy gel. To back this up, we can consider the various gel products that have already been on the market since the late 1990s. If Energy Bar consumers wanted to switch to Gel, there were already products on the market to fulfil their needs. However, Energy Bar still continued to experience steady growth and will continue if Energy Gel arrives on the market.
After we had accounted for all the incremental costs factoring into profits, we could find the before tax profits. This calculation can be followed in Chart 1 as ((2)-(3+4+5+6+7))=Pre-Tax Profits (8). Once we calculate ten years of Pre-Tax Profits, we can apply the Tax Rate (9) of 35 percent to get After-Tax Profits (10). The calculation at the bottom of Chart 1 is (8)*(9)= (10).
The first two years of after-tax profits are negative, meaning HPC will receive tax credits. We will