Question

In: Accounting

Robert Montoya, Inc., is a leading producer of wine in the United States. The firm was...

Robert Montoya, Inc., is a leading producer of wine in the United States. The firm was founded in 1950 by Robert Montoya, an Air Force veteran who had spent several years in France both before and after World War II. This experience convinced him that California could produce wines that were as good as or better than the best France had to offer. Originally, Robert Montoya sold his wine to wholesalers for distribution under their own brand names. Then in the early 1950s, when wine sales were expanding rapidly, he joined with his brother Marshall and several other producers to form Robert Montoya, Inc., which then began an aggressive promotion campaign. Today, its wines are sold throughout the world.

            The table Wine market has matured and Robert Montoya's wine cooler sales have been steadily decreasing. Consequently, to increase winery sales, management is currently considering a potential new product: a premium red wine using the cabernet sauvignon grape. The new wine' is designed to appeal to middle-to-upper-income professionals. The new product, Suave Mauve, would be positioned between the traditional table wines and super premium table wines. In market research samplings at the company's Napa Valley headquarters, it was judged superior to various competing products. Sarah Sharpe, the financial vice president, must analyze this project, along with two other potential investments, and then present her findings to the company's executive committee.

            Production facilities for the new wine would be set up in an unused section of Robert Montoya's main plant. New machinery with an estimated cost of $1,800,000 would be purchased, but shipping costs to- move the machinery to Robert Montoya's plant would total $80,000, and installation charges would add another $120,000 to the total equipment cost. Furthermore, Robert Montoya's inventories (the new product requires aging for 5 years in oak barrels made in France) would have to be increased by $100,000. This cash flow is assumed to occur at the time of the initial investment. The machinery has a remaining economic life of 4 years, and the company has obtained a special tax ruling that allows it to depreciate the equipment under the MACRS 3-year class life. Under current tax law, the depreciation allowances are 0.33, 0.45, 0.15, and 0.07 in Years 1 through 4, respectively. The machinery is expected to have a salvage value of $200,000 after 4 years of use.

            The section of the plant in which production would occur had not been used for several years and, consequently, had suffered some deterioration. Last year, as part of a routine facilities improvement program, $300,000 was spent to rehabilitate that section of the main plant. Earnie Jones, the chief accountant, believes that this outlay, which has already been paid and expensed for tax purposes, should be charged to the wine project. His contention is that if the rehabilitation had not taken place, the firm would have had to spend the $300,000 to make the plant suitable for the wine project.

            Robert Montoya's management expects to sell 125,000 bottles of the new wine in each of the next 4 years, at a wholesale price of $50 per bottle, but $30 per bottle would be needed to cover cash operating costs. In examining the sales figures, Sharpe noted a short memo from Robert Montoya's sales manager which expressed concern that the wine project would cut into the firm's sales of other wines-this type of effect is called cannibalization. Specifically, the sales manager estimated that existing wine sales would fall by 5 percent if the new wine were introduced. Sharpe then talked to both the sales and production managers and concluded that the new project would probably lower the firm's existing wine sales by $60,000 per year, but, at the same time, it would also reduce production costs by $40,000 per year, all on a pre-tax basis. Thus, the net externality effect would be -$60,000 + $40,000 = -$20,000. Robert Montoya's federal-plus-state tax rate is 40 percent, and its overall cost of capital is 10 percent, calculated as follows:

                                    WACC = Wd r d (1-T) + Wsrs

                                                = 0.5(10%) (0.6) + 0.5(14%)

                                                = 10%.

            Now assume that you are Sharpe's assistant and she has asked you to analyze this project, along with two other projects, and then to present your findings in a "tutorial" manner to Robert Montoya's executive committee. As financial vice president, Sharpe wants to educate some of the other executives, especially the marketing and sales managers, in the theory of capital budgeting so that these executives will have a better understanding of capital budgeting decisions. Therefore, Sharpe wants you to ask and then answer a series of questions as set forth next. Keep in mind that you will be questioned closely during your presentation, so you should understand every step of the analysis, including any assumptions and weaknesses that may be lurking in the background and that someone might spring on you in the meeting.

5. Estimate the project’s operating cash flows. (Hint: Again use Table 1 as a guide.) What are the project’s NPV, IRR, modified IRR (MIRR), and payback? Should the project be under-taken?

Fill in Xs. Payback period of S = about 2 years, L = about 3 years. Omit MIRR.

6. Now suppose the project had involved replacement rather than expansion of existing facilities. Describe briefly how the analysis would have to be changed to deal with a replacement project.

Depreciable basis = price + freight + installation. In year 1, 2,000,000 X 33% (or 0.33) MACRS factor = 660,000 (depreciation expense). 2,000,000 – 660,000 = 1,340,000 end-of-year book value.

            MACRS          Depr.               End-of-year

Year    Factor              Expense           Book Value

1         33%                     660,000                  1,340,000

2          X                     X                                 X

3          X                     X                                 X

4          7                     140,000                                0                   

            100%               1,800,000

                       

Cash Flow Statements:

                                    Year 0             Year 1             Year 2             Year 3             Year 4

Unit price                                            $           50       X                     X         $          50

Unit sales                                            100,000        X                     X              100,000

Revenues                                             5,000,000        X                     X         5,000,000

Operating costs                                   3,000,000        X                     X         3,000,000

Depreciation                                           660,000        X                     X              140,000

Other project effects                              20,000        X                     X                20,000

Before tax income                               1,320,000        X                     X         1,840,000

Taxes                                                     528,000        X                     X              736,000

Net income                                             792,000        X                     X         1,104,000

Plus depreciation                                    660,000        X                     X              140,000

Net op cash flow                                 1,452,000        X                     X         1,244,000

Salvage value                                                                                                       200,000

SV tax                                                                                                                            X

Recovery of NWC                                                                                                       X

Termination CF                                                                                                              X

Project NCF                ($-2,100,000)              X         X                     X                        X

                                    =========                =          =                      =                         =

Solutions

Expert Solution

Year MACRS/F Depr. EOY BV
0 2000000
1 33% 660000 1340000
2 45% 900000 440000
3 15% 300000 140000
4 7% 140000 0
100% 2000000
Cash flow Statement
Year 0 1 2 3 4
Unit price 50 50 50 50
Unit sales 125000 125000 125000 125000
Revenues 6250000 6250000 6250000 6250000
Less:
   Cash opg. Costs at 30/unit 3750000 3750000 3750000 3750000
   Depreciation as above 660000 900000 300000 140000
   Other project effects 20000 20000 20000 20000
Before tax Income 1820000 1580000 2180000 2340000
Less:Taxes at 40% 728000 632000 872000 936000
Net Income 1092000 948000 1308000 1404000
Add Back: Depn 660000 900000 300000 140000
Annual Opg. Cash flow--------1 1752000 1848000 1608000 1544000
a.After-tax salvage(200000*(1-40%) 120000
b.NWC introduced & recovered -100000 100000
c.Initial investment -2000000
Net annual cash flows(1+a+b+c) -2100000 1752000 1848000 1608000 1764000
PV F at 10% 1 0.90909 0.82645 0.75131 0.68301
PV at 10% -2100000 1592727 1527273 1208114 1204836
NPV 3432950
IRR 75%
MIRR 40%
Ordinary Pay back period
Net annual cash flows -2100000 1752000 1848000 1608000 1764000
Cumulative cash flows -2100000 -348000 1500000 3108000 4872000
1+(348000/1848000)=
1.19
Years
Discounted Pay back period
PV at 10% -2100000 1592727 1527273 1208114 1204836
Cumulative cash flows -2100000 -507273 1020000 2228114 3432950
1+(507273/1527273)=
1.33
Years
The project can be undertaken as it generates POSITIVE NPV
2.. If it is a replacement project, rather than an expansion one,we need to consider the incremental costs, incremental depreciation & tax shields available as well as incremental revenues , in the project analysis
It will be a sort of comparison with the existing one, from all angles, cost, revenues and tax savings.
The replacement should earn positive NPV so as to justify the change.

Related Solutions

Robert Montoya, Inc., is a leading producer of wine in the United States. The firm was...
Robert Montoya, Inc., is a leading producer of wine in the United States. The firm was founded in 1950 by Robert Montoya, an Air Force veteran who had spent several years in France both before and after World War II. This experience convinced him that California could produce wines that were as good as or better than the best France had to offer. Originally, Robert Montoya sold his wine to wholesalers for distribution under their own brand names. Then in...
According to the International Data Corporation, HP is the leading company in the United States in...
According to the International Data Corporation, HP is the leading company in the United States in PC sales with about 26% of the market share. Suppose a business researcher randomly selects 130 recent purchasers of PCs in the United States. (Round the value of ? to 2 decimal places. Round the values of z to 2 decimal places. Round your answers to 4 decimal places.) (a) What is the probability that more than 37 PC purchasers bought an HP computer?...
Robert Carbaugh asks the the question, "Can the United States continue to run a current account...
Robert Carbaugh asks the the question, "Can the United States continue to run a current account deficit year after year?" Carbaugh discusses the pros and cons of the U.S. government continually running a current account deficit. His arguments for and against current account deficits are quite compelling. Not only that, this question carries plenty of relevance being that we borrowed heavily to dig our economy out of recession. I would like for you to discuss in detail where you stand...
why the United States was “asleep at the wheel during the early 1970s” soon leading to...
why the United States was “asleep at the wheel during the early 1970s” soon leading to losses in competitiveness against Honda/Toyota/Sony. (Do not include wages)
The United States is home to some of the world's leading computer software companies, most of...
The United States is home to some of the world's leading computer software companies, most of which commonly outsource software development to other countries, including Egypt, India, Ireland, Israel, Malaysia, Hungary, and the Philippines. 1.Why do you think these countries became suppliers to the software industry? 2. Do you think that development of the industry in these countries is a threat to companies in the United States? Explain. Your response to each question should be a minimum of 6 sentences...
MNO, Inc., a publicly traded manufacturing firm in the United States, has provided the following financial...
MNO, Inc., a publicly traded manufacturing firm in the United States, has provided the following financial information in its application for a loan. The market value of equity is 1.58 times the book value of debt. Retained earnings are 5.27% of total assets. Sales are 52% of total assets. Earnings before interest and taxes are 32.87% of total assets. Finally, Working capital is 34.25% of total assets. a) What is the Altman discriminant function value for MNO, Inc.? b) Should...
Between 2002 and 2005, French wine exports to the United States dropped by nearly 18 percent....
Between 2002 and 2005, French wine exports to the United States dropped by nearly 18 percent. Some wine experts blamed part of the decline on what they perceived to be a drop in the quality of French wine. Others blamed a shift in U.S. tastes in favor of domestic wines, and others suggested U.S. residents’ unhappiness with the French government’s foreign policies. Economists offered a different explanation. During 2003, the dollar depreciated by almost 20 percent relative to the euro....
New Leaf Feetilizer is an emerging fertilizer producer in thevMidwestern region of the United States. After...
New Leaf Feetilizer is an emerging fertilizer producer in thevMidwestern region of the United States. After a prolonged drought damaged farmers production last year, New leaf Fertilizer has seen a subsequent decline in profits, forcing cutbacks in several areas of the company. Compounding those problems, a nre government mandate- in repsonse to the reports that the chemical dichloramine 5, in its unrefined state, causes rashes and skin discoloration- requires all handlers of dichloramine 5 to be certified. this checmial os...
The United States does not allow oranges from Brazil​ (the world's largest producer of​ oranges) to...
The United States does not allow oranges from Brazil​ (the world's largest producer of​ oranges) to enter the United States. If Brazilian oranges were sold in the United​ States, oranges and orange juice would be cheaper. Use the laws of demand and supply to explain whether the above statement is true or false. If Brazilian oranges are sold in the U.S.​ market, then the​ _________ will​ increase, the price of oranges ​ _________. A. quantity of oranges​ supplied; will​ fall,...
In 2006, the five leading suppliers of digital cameras in the United States were: Canon, Sony,...
In 2006, the five leading suppliers of digital cameras in the United States were: Canon, Sony, Kodak, Olympus, and Samsung. The combined market share of these five firms was 60.9 percent. The leading firm was Canon, with a market share of 18.7 percent. The own-price elasticity for Canon’s cameras was -4.0 and the market elasticity of demand was -1.6. Suppose that in 2006, the average retail price of a Canon digital camera was $240 and that Canon’s marginal cost was...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT