Case Study for Moon Bakery

Moon Bakery Case Study – (Excel Template attached in different file)

Based on the information provided in the case study, Moon Bakery should look to invest in the $350,000 machine. Here, the Net Present Value of the investment is positive indicated that the machine will add value to the business if the project is undertaken. Likewise, from the payback period analysis, the company should look to receive a payback on the investment in at least 3 to 4 years. This is beneficial as the machine is expect to be functional for at least six years.

When reviewing the data, the risk of undertaking the project is low given the projected increases in revenue along with long duration of the asset being used. In addition, Jane may want to consider financing a portion of the purchase with debt. Here, the company has a very low cost of debt and very little leverage. By financing a portion of the purchase with debt, the company can lower the overall risk of the project and bring their overall cost of capital down. Based on the projections the current yield on the asset in Year 1 is 16%. This is calculated as the net income projected in year 1 divided by the capital expenditure of $350,000. As this current yield of 16% is much higher than the cost of debt of 4%, the company can also generate additional revenues and provides by leveraging this “spread” to invest in further machinery using debt financing. This becomes particularly attractive if the company can secure debt financing with very long durations at a fixed rate of roughly 4.5%. Here, if the projections turn out to be correct, the company can use debt very conservatively to purchase additional machinery, and profit from the spread of the current yield with that of the debt costs. This debt can then be services from the free cash flow that will occur from the increase in revenue and sales due to the machinery.

Overall, the company should undertake the project and invest in the machine. It first provides a limited competitive advantage as it increase efficiencies and revenues for the business. These revenues are justified by the positive NPV calculations as noted in the attached template. In addition, the payback period is relative short, thereby indicating a strong investment opportunity. Finally, through the use of debt, the company can profit from the current yield on the asset and its very low debt costs. By conservatively increasing leverage, the company will in turn, lower its cost of capital as well further justifying the investment.