Red Hen Case Study Essay Example

Red Hen Case Study Paper Red Hen Baking Company Red Hen Baking Company Case Study Company profile Randy George established Red Hen Baking Company in 1999. Red Hen Baking Company specializes in artisan bread and their mission is â€Å"to produce premium quality breads and pastries with traditional methods and carefully selected high quality ingredients. To do this while striving to minimize our impact on the environment, to support the growers and producers of our ingredients, and to provide the finest baked goods and service to our customers† (Our Mission). Red Hen Baking Company is able to achieve their mission by marketing their baked goods within 100 miles of the bakery and by delivering every day to stores and restaurants in the delivery area. Problem Opportunities Red Hen Baking Company is currently located in a building that is not suited for a bakery and the space is very limited. The building has low ceilings and it is too small to design an efficient production process. The current bakery only has a capacity limit of 2200 loaves of bread a day. In 2006 Randy George began to realize that he would soon need a larger location in order to keep up with the demand of his current customers. RHB’s business is seasonal. Holiday weekends see increased sales, often reaching their daily limit of 2200 loaves. The sales in the first half of 2007 are already 35% higher than sales during this same period in 2006 and days where production cannot meet demand are expected to increase in number. George would like to house the bakery in a new location that has high ceilings and is about twice the size of the Duxbury location. We will write a custom essay sample on Red Hen Case Study specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on Red Hen Case Study specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on Red Hen Case Study specifically for you FOR ONLY $16.38 $13.9/page Hire Writer He would then be able to install a more efficient oven and design a more efficient production process. He would also be able to produce 3300 loaves on a daily basis, giving him ample room for growth. George also wants a location where he can sell breads and pastries directly to retail customers. If he adds pastries to his menu, George knows that he will have to hire a baker with pastry experience. George also knew that the ingredient cost will rise due to the cost of ingredients used in organic pastries. What has been a 15% cost could now be 25%. The problem George is facing involves the substantial costs involved with a move like this. Altogether, the build-out, the oven, and other moving expenses would cost about $300,000. The rent will also be about four times as much as the current rent expense at the Duxbury location, which comes to an additional $58,000 annually. He wonders whether the opportunity for growth is worth the financial strain. Relevant Credible Information Since the case is somewhat incomplete with no inclusion of a balance sheet to aid in decision making, we will instead base our proposed course of action on the information provided by the income statement. We are also taking into account the additional assumptions provided by the professor. Our analysis is based on financial ideas and information discussed in class, found in the text, and learned in previous classes. Assumptions * Assuming the current debt carries an interest rate of 12. 0% with current payments of $2,212 per month with an outstanding balance as of 06/30/2007 is $34,360. * The attached spreadsheet shows an amortization table which breaks down interest and principal for current debt. We found remaining months for the table by performing a present value calculation for the outstanding balance of $34,360. * Red Hen can take on additional debt as long as the EBITDA/Loan Payments is 3. 5x or greater. Assume any new loan will be at 9% and will be a 10-year amortizing loan. From our calculations, we assume that George is able to take on the new debt. * An amortization table was created for this new debt. We wanted to find an amount for the loan payment that could be plugged into the Debt Service Coverage Ratio (EBITDA/Loan Principal + Interest Expense). From the Income Statement on the spreadsheet, we have EBITD for January through June of 2007. Red Hen’s ratio before taking on the expansion is 5. 20, which is much higher than the required minimum of 3. 5. Analysis Our analysis attempts to answer the question, â€Å"What are the things a company must consider when analyzing a new investment or project? † According to the text, a firm’s first object ive when deciding to take on new debt should be that its return on net assets (RONA) should be greater than its weighted average cost of capital (WACC). Since we are working with an income statement only and do not have an amount for net assets, we will instead use return on invested capital (ROIC), which measures how well a company is using its money to generate returns. Comparing a companys return on capital (ROIC)  with its cost of capital (WACC) reveals whether invested capital was used effectively. From our spreadsheet calculations we see that using our estimated operating profit provides us with a 19. 9% return on invested capital with only a 7. 2% weighted average cost for that same capital. If these numbers are even close to correct, George should definitely make the move. The actual numbers will differ from what has been estimated here, of course. Not all of the expenses will increase by 30% in response to 30% growth. Many of the expenses listed are fixed and do not change in relation to changes in production levels. Expenses that do change in this way would most likely be in the cost of goods sold section of the income statement. Depreciation will markedly increase with expansion. This has been accounted for on the income statement. As a tool for analysis, however, I have chosen to add a 30% markup to all other expenses that are specifically mentioned in the case study. Rent expense, interest expense, and depreciation have each been increased in accordance with information found in this article. What we see here is that the opportunity for expansion should be taken. George seems to be in good shape to make the move and should excel at the new location. Alternative Courses of Action An alternative decision George could make would be to not move from his current location. If George decided to stay in his cramped and inefficient facility, growth of RHB would not be able to support the demand of the customers. According to the analysis, RHB would increase sales at a consistent 30% annual rate. Staying in the same location, George would not experience the rapid growth in profit. In the long run, George would continue to have a steady base line of sales staying in the current location. Works Cited Our Mission. (2011). Retrieved from http://www. redhenbaking. com/ Preve, Lorenzo and Virginia Sarria-Allende. Working Capital Management. New York: Oxford University Press, 2010. Return on Invested Capital. Retrieved November 3, 2011 from http://news. morningstar. com/classroom2/course. asp? docId=145095;page=9;CN=COM [ 1 ]. See spreadsheet and note cell formula in formula bar. Oven is estimated to last seven years and building twenty. For simplicity, no salvage value was considered. [ 2 ]. Rent expense was expected to increase by $58,000 a year. Half of that amount has been added to the $12,000 they would have paid at the Duxbury location. Interest expense came from amortization tables.