Question

Jim Beam is considering investing $ 10 million to create a new whiskey based on George Washington original recipe using authentic Revolution War-era equipment. If successful, Beam plans to expand the line to include a whole line of historic distilled spirits. A financial analysis of the cash flows from the Washington whiskey investment suggests that the present value of the cash ows from this investment to Jim Beam will be only $ 7 million. Thus, by itself, the new channel has a negative NPV of $ 3 million. If the market for the Washington spirit turns out to be more lucrative than currently anticipated, Jim Beam could expand its historical spirit line with an additional investment of $ 15 million any time over the next 20 years. While the current Expectation is that the cash in flows from historic spirits is only 6 million (both figures in present-day dollars) as evidence by the recent resurgence in bourbon sales. there is considerable uncertainty leading to significant uncertainty in this estimate. what is the minimum level of discounted cash inflow for the historical spirit line expansion necessary to make the option to expand viable.

Answer 1

Solution :-

Here , in the question Clearly given that the Discount Cash flows from the Washington whiskey investment is less than its Investment , so it has a negative NPV of $3 million ( As initial investment is $10 million and Value of Discounted Cashflows is $7 million ) , As NPV is acceptable if it is Greater than Equal to Zero

Now If the market for the Washington spirit turns out to be more lucrative than currently anticipated , there is new condition pf investement in historic spirits  of $15 million But the current Expectation from this of Discounted Cashflows is $6 million Therefore the NPV of it also comes negative i.e $ 9 million ( $15 - $6 )

Now the he minimum level of discounted cash inflow for the historical spirit line expansion necessary to make the option to expand viable is More than or equal to $15 million . Now when its discounted Cashflows are minimum $15 million then it has a NPV greater than equal to Zero which makes the option to expand viable as NPV is accepted only if greater than equal to Zero.