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In: Finance

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?

Solutions

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%

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