The evaluation of the company’s project or product can be carried out using Net Present Value (NPV) analysis. The NPV analysis involves forecasting of future cash flows that the business expects to generate from the new project or its product. The cash flows are discounted using an appropriate discount rate that is the cost of capital of the company. The cost of capital is the cost of funds acquired by the company from different sources including equity and debt. The sum of present value (discounted value) is deducted from the initial investment cost to determine the net present value. If the NPV is positive, then the company should go ahead with the project or continue with the product. Furthermore, the NPV analysis is supported by the calculation of Internal Rate of Return (IRR). The IRR is the rate at which the NPV becomes zero. It is the minimum rate of return that the business needs to generate on its project or product to cover its investment costs. In the current analysis, the case of Monster Beverages Company and its product Monster Energy Drink is considered.
The company is already producing and selling Monster Energy Drink. However, it is assumed for this report that the company is planning to introduce a new product that is Monster Energy Drink. The amount of initial investment is assumed and presented in the following table.
The company has estimated operating profit for the sale of Monster Energy Drink for one year. It is provided in the following table.
For the current analysis, the operating income is considered as the cash flow expected by the company from the sale of Monster Energy Drink. Furthermore, the analysis requires at least three years of projections. It is assumed based on the estimation of the economic life of the machinery before additional investment will be required. Therefore, the project life is three years and the cash flows are projected for the next years. Furthermore, the company assumes that the operating income of Monster Energy Drink will grow by 5% in Year 2 and Year 3. The growth rate is based on the historical data of the company. The selling and administrative expenses related to Monster Energy Drink operations are estimated to increase by 2% in Year 2 and Year 3. The future cash flows (operating income) are provided in the following table.
The net present value is calculated in the following table.
The following table provides estimate of the internal rate of return (IRR).
The internal rate of return is 16.02% (approximately) by using trial and error method. At this rate the present value of future cash flows is equal to the initial investment amount that results in zero value of net present value. This is the rate that the company can expect to achieve from the new project. It is greater than the cost of capital (10%) that implies that the new product will generate a high return for the company. It could be suggested that the company should accept the new project of producing and selling Monster Energy Drinks.
References
Brigham, E. F.., & Ehrhardt, M. (2007). Financial Management: Theory & Practice. Boston, MA: Cengage Learning.
Brigham, E. F., & Daves, . R. (2014). Intermediate Financial Management. Boston, MA: Cengage Learning.
