Question

Your group works in the Corporate Finance department of Dogwood Winery. Management is considering releasing a new line of wines and has asked you to conduct an analysis of the project. You will be presenting your results to senior management.

The new wines sell for $38 per litre and have a variable cost of $11 per litre. The company has conducted a marketing study which cost the company $70,000, and the study suggested that sales will be 58,000 litres per year for the next nine years.

Given the popularity of the new wines, the marketing study also expected that sales of its luxury rosé wines will decline by 55,000 per year. The luxury rosé wines sell for $180 per litre and have variable costs of $68 per litre. The company will also increase sales of its inexpensive red wines by 65,000 litres per year. The inexpensive red wines sell for $13 per litre and have variable costs of $10 per litre. The fixed costs each year will be $520,000.

A famous actor has agreed to sponsor the new line of wines and to defer payment until the year after the company reached sales of $12,180,000 cumulatively. Payment for sponsorship would be a one-time payment of $89,000. The company also spent 62,000 on research and development for the new wines.

New equipment to manufacture the new line of wines is $880,000 and qualify for depreciation at a CCA rate of 33 percent. The new line of wines will also need an incremental new working capital of $960,000 that will be returned at the end of the project. The tax rate is 23 percent, and the cost of capital is 16 percent. Assets will remain in the CCA class after the end of the project.

Required: Calculate the payback period and the NPV. Provide a recommendation for senior management. Should the company proceed with the project?

Your manager has asked for two components:  

Q. An Excel spreadsheet showing detailed calculations of each component of the cash flow analysis for each year of the project horizon.  In the final column of your table, provide an explanation in words for each row of calculations in your table.  Show the payback period and NPV calculation in the spreadsheet.

Answer 1

Recommendation: NPV is negative which means money generated in future will not worth more than the initial cost. Hence, project should not be accepted. If this project will be accepted it will lead to decline in sales of other products of company.

While Payback period is quite low which is good but it won't give the true picture due to it's drawback of not considering the time value of money. It's calculation does not consider the negative inflows as well.

Research and development cost is assume to be sunk cost.