This case study examines Moon Bakery's capital investment decision for a $350,000 machine using comprehensive financial analysis methods. The analysis employs Net Present Value calculations, payback period assessment, and debt financing evaluation to recommend the investment. The study demonstrates how businesses can optimize capital allocation decisions through quantitative analysis while considering risk factors and financing strategies.
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.
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