Case01

Posted on February 2, 2017

Bubba Bubble Gum Case Study Analysis Help with Solution

Bubba’s Ballpark Bubble Gums has been actively searching for expansion opportunities. My hapless brother, Hairy, has identified what may be a juicy alternative. However, Hairy is known for hatching half-baked and hare-brained ideas. Therefore, I want you to make sure this baby won’t blow up in my face.
Our scientists have developed a new bubble gum aimed at the baseball market. The gum comes in both original and apple flavors. Each piece will be wrapped in waxed paper that bears the team’s logo and colors. In addition, each piece of gum will be stamped with the team’s logo. The real kicker is that every time you blow a bubble, the team’s logo will appear across it! You may be saying to yourself, “Bubba, I don’t want to burst your bubble, but that sounds like bogus bubble gum.” Quite the contrary, our scientists have developed the gum and are chewing numerous packs right now. This gum was a product of our top secret R&D program, code- named “BubbaGum.” Please see the attached mock-up of our advertising campaign so you can visualize the product.

I am sure you can see the tremendous opportunity for such a product. As a matter of fact, if the baseball phase of this product is successful, we plan to roll it out into other entertainment markets nationwide. We are currently developing a line of gums called MovieMasher to be sold in movie theaters, including the following flavors: TopGum, ShoGum, ForestGum, NakedGum, GumSmoke, and Gum with the Wind.

I need your assistance in analyzing this opportunity. I am confident in our scientists’ ability to develop these products but worried about the market potential. To take advantage of the baseball market opportunity, we will need to improve and modernize our existing facilities. Given the tight financial situation in our company, I would like you to estimate the total value of this investment on a discounted cash flow basis. We need a very good understanding of the cash flows from this venture before we undertake the modernization. Hairy has given me an estimate, but I want to double-check his calculations so we don’t blow this deal.

Attached is a list of assessments and assumptions to be used in your projection of cash flows. I have also included the standard definitions and equations we use in our financial models. As we learn more about this opportunity in the coming weeks, we will revise many of these assessments. Therefore, I would like you to create a spreadsheet model that can be changed easily. The model should calculate the net present value (NPV) of estimated cash flows from the venture over 20 years.
Market Size
The bubble gum market size last year was 950,000 packages, each containing 5 pieces of gum. We anticipate a market growth of 2%/year for the next 20 years.
Timing
We need a projection of cash flows for the 20-year period , including this year (Year 1). The plant improvements will begin and end during next year (Year 2). We will launch the product the year after (Year 3).

Market Share and Sales Volume
We could attain a peak market share of 65% within a year of the product launch, assuming that we have the capacity to satisfy demand. This share would remain constant for 12 years, and then sharply decline to a residual market share of 15%. For modeling purposes, you may approximate this by a two-step function, with the first step occurring 1 year after the product launch and the second step 12 years later.

 

Unfortunately, our distribution network imposes a limit on our capacity to satisfy all the potential demand. At present, our maximum sales capacity is only 500,000 packages per year, but it is increasing each year by an additional 40,000 packages per year. For example, our sales capacity next year (Year 2) will be 540,000 packages. Our actual sales volume in any year will be the smaller of: 1) our sales capacity in that year or 2) the market size times our potential market share in that year.
Price, Costs, and Expenses
The wholesale selling price at launch will be $1.00/package, decreasing at a real (without inflation) rate of 3%/year, to a floor of $0.85/package. Variable cost of the product will be $0.25/package. The additional fixed operating costs needed to support this new product will be $60,000/year, starting the year of product launch (Year 3). The plant improvement will require a capital expenditure of $150,000, and this investment will be made next year (Year 2). Ongoing marketing costs will be 10% of sales, distribution costs will be 4% of sales, and general & administrative costs will be 6% of sales.

Other Assessments

  • Use a discount rate of 8% to compute the NPV of real (i.e., uninflated) cash flows.
  • We need working capital equal to 12% of revenues.
  • Use straight line depreciation over 5 years, starting the year after the capital investment.
  • Our net corporate tax rate is 38% of operating income.

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BubbaGum Opportunity Definitions and Equation

  1. Cost of Goods Sold (COGS) = Variable Costs + Fixed Operating Costs
  2. Gross profit = Revenue – Cost of Goods Sold (COGS)
  3. Depreciation =20% of the invested capital each year for 5 years, zero thereafter
  4. Operating income =Gross Profit – Expenses – Depreciation
  5. Tax =Operating Income x Tax Rate
  6. Net income after tax =Operating Income – Tax
  7. Cash flow =Net Income + Depreciation – Capital Expenditure – Change in Working Capital
  8. Working capital =Money required to cover time lags between when you pay for inputs and when you receive revenues

NPV of cash flow = Σni  Cash  Flow/i=1(1 + Discount Rate)i

(See Excel “Help” for information on the built-In NPV function)
For this problem you are to complete the bubbagum case we started in class. The case, influence diagram, and spreadsheet template are posted on canvas.

(a) Build model referring to the case,influence diagram,and model template,complete the bubbagum model.make sure to use the modelling convetions we discussed.this includes range names,no battleship code,consistent formulas,etc.
(b)Analysis compute the NPV of the bubbagum opportunity. Should bubba invest? Develop a couple of waterfall diagrams to support your recommendation. What if some assessment (inputs) changed?would your recommendation change?

 

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