Question

V. Rahr and Sons is a Fort Worth brewery founded by Fritz Rahr, a Neeley undergraduate and MBA. Currently the company makes Rahr Blonde Lager, Rahr’s Red, and Ugly Pug brews. They are considering a new beer, Frog Princess, with which to celebrate their ties to TCU. The project includes an initial outlay of $750,000 for the purchase of capital equipment that will be depreciated straight line to zero over six years.

Sales are expected to be $400,000 in years 1-3 and $600,000 in years 4-6. Production costs during years 1-6 are as follows: fixed costs (not including depreciation) are expected to be $150,000 per year; variable costs per year will be 40% of sales. The project will require an initial investment in NWC of 200,000 in year 0.

Beyond year six, the company expects that sales and unlevered net income in year seven will be 4% higher than that in year 6, and will continue growing at 4% per year infinitely. Additionally, in year 7 and beyond, new capital expenditures net of depreciation, and increases in NWC, combined, will be 6% of sales. Assume the marginal tax rate is 21%. The appropriate discount rate is 8%.

What is the NPV of the project? What is the IRR? Should the project be undertaken?

Answer 1

NPV : 3,170,936

For the purpose of taxation consider depreciation over 6 years and the depreciation should not be considered for NPV

For Year 7, use discounting rate of =8%-4%

There is no tax outflow in years 1-3 as the project is in losses after considereing for depreciation

Cash flows:

0 Year    750000+250000

1 year    400000-150000-160000-(21%*(400000-150000-160000-125000) (Revenue-FC-VC-(tax%*(Revenue-FC-VC- depreciaion)

2 year    400000-150000-160000-(21%*(400000-150000-160000-125000) (Revenue-FC-VC-(tax%*(Revenue-FC-VC- depreciaion)

3 year    400000-150000-160000-(21%*(400000-150000-160000-125000) (Revenue-FC-VC-(tax%*(Revenue-FC-VC- depreciaion)

4 -6 year    600000-150000-240000-(21%*(400000-150000-160000-125000) (Revenue-FC-VC-(tax%*(Revenue-FC-VC- depreciaion)

7 year    624000-150000-249600-(21%*(400000-150000-160000-125000)-37400 (Revenue-FC-VC-(tax%*(Revenue-FC-VC- depreciaion)-additional capex(6% of 624000)

IRR: Approximately 28%. Yes the project should be undertaken