Budweiser is thinking about making wine… • Expected sales per unit o 260,000 bottles sold in...

Budweiser is thinking about making wine…

• Expected sales per unit o 260,000 bottles sold in the first year o Sales revenue declines 10% per year (ie, sales growth = -10%)

• Proposed selling price per bottle = $5.20

• Variable cost per bottle = $2

• Fixed costs = $250K/year in maintenance and labor

• Budweiser also expects to lose $300K pretax per year (revenue net of expenses) from beer sales as people switch from beer to wine

• Working capital necessary = $50K

• Wine-making equipment o would cost $750K, plus $50K in modifications required on the assembly line (included in depreciable basis)

o depreciated 5-year MACRS

• After five years, project ends as everyone realizes Budweiser wine is disgusting o all remaining working capital recouped o wine-making equipment sold for $400,000

• Tax rate = 30%

• Assume any negative taxes can be treated as an immediate tax credit. (=treat negative taxes as a positive CF.)

• Required return = 10%.

On Excel, calculate the NPV and the IRR of the project. Should the company pursue this project?

Expert Solution

Year	0	1	2	3	4	5
initial Investment in machine =750000+50000	-800000						year	cost of equipment	MACRS rate	Annual depreciation
Investment in working capital	-50000						1	800000	20%	160000
sales in units =sales in Year 1*(1-r)^n r =-10% n =1,2,3,4		260000	234000	210600	189540	170586	2	800000	32%	256000
sales revenue =units sold*sales in units		1352000	1216800	1095120	985608	887047.2	3	800000	19.20%	153600
variable cost		520000	468000	421200	379080	341172	4	800000	11.52%	92160
fixed cost		250000	250000	250000	250000	250000	5	800000	11.52%	92160
Annual depreciation		160000	256000	153600	92160	92160	Accumulated depreciation over a period of 5 years			753920
operating profit		422000	242800	270320	264368	203715.2
pre tax loss of net revenue		300000	300000	300000	300000	300000	Book value of equipment	800000-753920		46080
before tax net revenue		122000	-57200	-29680	-35632	-96284.8	selling price			400000
tax-30%		36600	-17160	-8904	-10689.6	-28885.4	Gain on sale of equipment			353920
after tax profit		85400	-40040	-20776	-24942.4	-67399.4	Tax on gain on sale of equipment	353920*30%		106176
add depreciation		160000	256000	153600	92160	92160	after tax sale proceeds		400000-106176	293824
after tax scrap value of machine						293824
recovery of working capital						50000
net operating cash flow	-850000	245400	215960	132824	67217.6	368584.6
present value factor at 10% =1/(1+r)^n r=10% n=1,2,3,4,5	1	0.909091	0.82644628	0.751315	0.683013	0.620921
present value of cash flow	-850000	223090.9	178479.339	99792.64	45910.53	228862.1
Net present value = sum of present value of cash flow	-73864.53
IRR =Using IRR function in MS excel	IRR(R1195:W1195)	6.59%
No project should not be pursued as NPV is negative and IRR is less than required rate of return of 10%

jeff jeffy answered 2 years ago

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