3. Capital budgeting. Põltsamaa Felix, an exclusive Estonian wine producer, is c
ID: 2806104 • Letter: 3
Question
3. Capital budgeting. Põltsamaa Felix, an exclusive Estonian wine producer, is considering the purchase of 10,000 French oak barrels at a cost of 900 eur each. The investment into barrels is considered a capital expense and would be depreciated straight line over 5 years. After 4 years, the barrels will be useless for making fine wine, but they expect to be able to sell them for 3 million eur to Gallo. The increase in the quality of its sweet apple line of wines due to the use of the new French oak barrels is expected to increase revenue by 7 million eur (only) in years 3 and 4. The barrels would have no influence on COGS, SG&A, other operating expenses. The additional working capital investment is 10% of the additional sales revenues and is fully recovered when the project ends (in four years). The tax rate is 40% (profits are taxed), and the required return is 12%.
a) Construct the capital budget
b) Evaluate the project on the basis of NPV and MIRR.
Explanation / Answer
1a) Capital Budget:
0
1
2
3
4
Capital Outlay (10,000*900)
-9,000,000
Revenue
0
0
7,000,000
7,000,000
Less: COGS
0
0
0
0
Less: SG&A
0
0
0
0
EBITDA
0
0
7,000,000
7,000,000
Less Depreciation: (9,000,000/5)
1,800,000
1,800,000
1,800,000
1,800,000
EBIT
-1,800,000
-1,800,000
5,200,000
5,200,000
Less: Tax (0.40* EBIT)
0
0
2,080,000
2,080,000
Net Income
-1,800,000
-1,800,000
3,120,000
3,120,000
Plus: Depreciation
1,800,000
1,800,000
1,800,000
1,800,000
Less: Working Capital Investment
0
0
700,000
700,000
Plus: Recovery of Working Capital
1,400,000
Plus: Sale of Barrel
3,000,000
Cash Flow
-9,000,000
0
0
4,220,000
8,620,000
PV of Cash Flow@ 12%
-9,000,000.00
0.00
0.00
3,003,712.65
5,478,165.84
1b) Therefore, NPV (Sum of all PV of Cash Flow)=Eur -518,121.52
To calculate MIRR: (Future Value of + Cash Flow/ Present Value of Negative Cash Flow)1/n -1
Future Value of + Cash Flow= (Year 3 into 4)+ Year 4 cash flow : (4,220,000)* (1.12)= 4,726,400+ 8,620,000= Eur 13,346,400.
Therefore, MIRR= (13,346,400/9,000,000)1/4-1 =10.35%
Conclusion: Since NPV is negative and MIRR is less than the cost of capital (12%) the project should not be accepted.
0
1
2
3
4
Capital Outlay (10,000*900)
-9,000,000
Revenue
0
0
7,000,000
7,000,000
Less: COGS
0
0
0
0
Less: SG&A
0
0
0
0
EBITDA
0
0
7,000,000
7,000,000
Less Depreciation: (9,000,000/5)
1,800,000
1,800,000
1,800,000
1,800,000
EBIT
-1,800,000
-1,800,000
5,200,000
5,200,000
Less: Tax (0.40* EBIT)
0
0
2,080,000
2,080,000
Net Income
-1,800,000
-1,800,000
3,120,000
3,120,000
Plus: Depreciation
1,800,000
1,800,000
1,800,000
1,800,000
Less: Working Capital Investment
0
0
700,000
700,000
Plus: Recovery of Working Capital
1,400,000
Plus: Sale of Barrel
3,000,000
Cash Flow
-9,000,000
0
0
4,220,000
8,620,000
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