WONDERLAND CONFECTIONARIES CASE STUDY

Wonderland Confectionaries Case Study

Wonderland Confectionaries Case Study

Introduction

This paper is based on a case study that revolves around firm called wonderland confectionaries, a successful restaurant business franchise. The company is now interested in establishing a theme park, which is going to attract according to estimates 7000 visitors per day. We have some prior information available and on that basis, we have to write a report suggesting an operational framework for the theme park to be a successful venture.

Net Present Value

The fundamental importance of the NPV concept to the financial management of the firm (such as Wonderland Confectionaries in this case) lies in the fact that investment projects with positive NPV increase the wealth of the firm (such as Wonderland Confectionaries in this case)'s shareholders by that amount, whereas projects with negative NPV reduce shareholder wealth. Because the paramount objective of the financial manager should be to maximize the wealth of the firm (such as Wonderland Confectionaries in this case)'s current shareholders, it follows that management should undertake only investment projects with positive NPV. Unfortunately, sometimes the manager's own objectives may be in conflict with shareholders' wealth maximization, although this problem of diverging objectives may be mitigated by carefully designing the manager's compensation contract.

Potential Implementation Problems

NPV is an invaluable tool for the financial management of the firm (such as Wonderland Confectionaries in this case); it may lead to faulty decisions if its implementation is incorrect. Indeed, note from the above general formula that the correct computation of the NPV technique critically depends on choosing an appropriate value for the discount rate (rate of return), “r”.

The appropriate rate, in turn, depends on the risk level of the project. In practice, however, the risk level is often difficult to ascertain with precision. Because of this difficulty, an erroneous choice of discount rate may indicate that a project should be rejected when, in fact, it should be accepted. Of course, the converse may occur as well. These potential errors, if left unchecked, may have a deleterious effect on the value of the firm (such as Wonderland Confectionaries in this case).

NPV Profile

A useful tool for checking the sensitivity of the NPV to the choice of discount rate, r, is the NPV profile, which provides a visual representation of the NPV of a project for a variety of discount rates. For the numerical example given above, the NPV profile has a downward-sloping shape. Indeed, substituting r = 0, 0.1, 0.2, 0.3, 0.4, and 0.5 in the general formula produces NPV = $1,641, $1,000, $527.20, $167.96, -$111.88, and -$334.52, respectively. Recall that the firm (such as Wonderland Confectionaries in this case)'s required discount rate is r = 0.10, or 10%, so its estimated NPV is $1,000. However, if the firm (such as Wonderland Confectionaries in this case) is unknowingly mistaken in choosing that value of r, then the NPV profile may visually reassure the firm (such as Wonderland Confectionaries in this case) that even a relatively large error in either direction may not be critical ...