Põltsamaa Felix, an exclusive Estonian wine producer, is considering the purchas

Question

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

a.

b. NPV:

as NPV is negative, project is rejected.

IRR= 11.4321% at which NPV is around 0.

Capital budget Year 0 Year 1 Year 2 Year 3 Year 4 Barrels purchase         (9,000,000) Working capital investment         (1,400,000) Barrels salvage value          3,000,000 Working capital recovery          1,400,000 Total capital cash flow       (10,400,000)                -                  -                  -            4,400,000

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