You have recently been informed that Golden Barrel Distillery is considering the development of a new product
Question:
You have recently been informed that Golden Barrel Distillery is considering the development of a new product offering, specifically the launch of a 20-year-old double barrel single malt whisky. The new product is a critical feature in a draft competitive bid being prepared by the company to exclusively supply a national alcohol retailer. You are required to evaluate the project before it is submitted to the CFO for final review.Essential information relating to the project has already been prepared by the finance team, alongside the assistance of operational managers. The project calls for Golden Barrel Distillery to produce and deliver 485,000 bottles of the new 20-year-old whisky over a 16-year exclusivity period. The proposed selling price to the retailer, inclusive of shipping fees, is fixed at $178 per bottle. The product is anticipated to be sold by the retailer at a recommended retail price (RRP) of $234.99 per bottle but may be discounted to increase product demand and awareness. While Golden Barrel Distillery would be required to supply the retailer for a 16-year period, lead times in developing and finalising this new product are estimated to be an additional two years - thus sales relating to the project will not commence until year three of the projects 18-year life. Golden Barrel Distillery is proposing to supply the following quantities per year to the national retailer:Year Units Year Units 1 0 10 39,850 2 0 11 3 10,950 12 4 14,000 13 5 18,500 14 6 21,750 15 7 27,250 16 8 31,000 1742,50041,00038,50037,85033,50032,00030,500 9 36,000 18 29,850 Total 485,000While you have previously evaluated projects in other industries before, this bid is unusual in a few ways. First, if accepted by the national retailer, this project would commit Golden Barrel Distillery to a fixed- price long-term contract. Second, producing the new single malt whisky would require a significant upfront investment to purchase machinery, bottle mouldings, necessary casks, and refurbish one of Golden Barrel Distillery's existing buildings/plants. Third, the plant to be utilised for this project (titled Refined Grain Estate) is in a valuable agricultural valley and could alternatively be sold by Golden Barrel Distillery.Other details relevant to the appraisal of the project include:? The negotiated price paid by the national retailer per bottle is fixed for the duration of the contract,along with the specified quantities each year.? Due to Golden Barrel Distillery previously centralising their production sites, Refined Grain Estateis now idle. The plant was purchased in 1976 and has been fully depreciated, except for the originalpurchase price of $240,000.? Refurbishing the plant is anticipated to cost $8,725,000 and would be depreciable on a straight-linebasis over the next 15 years.? The necessary machinery and equipment are projected to cost $2,350,000 in total and would bedepreciated on a straight-line basis over the next 10 years.? The additional casks required to be purchased for the new product are estimated to cost $150,000in total and would also be depreciated on a straight-line basis over 10 years.? Cost of goods includes fixed costs of $380,000 per year plus variable costs of $12.40 per bottle.These costs are expected to increase at the annual inflation rate.? Working capital is expected to average about 9% percent of annual sales.? The excise duty on spirits is currently $92.81 per litre of pure alcohol - thus, Golden Barrel Distillery is required to pay roughly $28.26 (700ml bottled at 43.5%) per bottle sold, in addition tothe marginal tax paid on annual net income. This excise duty is anticipated to remain constant forthe foreseeable future and should be treated as an operational expense.? Recent valuations estimate Refined Grain Estate could be sold immediately, or in the near future,for $5,400,000 (inclusive of the land). Estates in the area are projected to appreciate roughly 3.85%per annum over the next 20 years.? The refurbished plant, machinery, equipment, and casks are all expected to last for many years ifmaintained. However, due to strong competition in the single malt whisky market, it is unclear whether a subsequent supply agreement with this national retailer, or another, could be obtained once this proposed contract ends. The capital investments required for this project are specialised for this new product offering, and hence their resale value at the end of this 18-year project is estimated to be zero at this stage.Given the stature of the client for this proposed contract, the annual sales aspect is considered low risk and hence it is believed the discount rate used for evaluation purposes should be 2% lower than Golden Barrel Distillery's standard WACC.Golden Barrel Distillery's business development manager has recently received a confidential letter of interest. It contains the details of a proposed offer from a start-up distillery to purchase the Refined Grain Estate (land and plant) for $4,800,000 - although, you have noticed the offer is subject to Council approval for development of the land and merger of titles with an adjacent property.Should you recommend submitting the bid for this competitive tender at the proposed price of $178 per bottle, or make a counteroffer? Comment on critical issues to be considered, including the offer from the start-up distillery. This report will be distributed to a wide audience (mixed professional backgrounds) at Golden Barrel Distillery, and as such, must include at least three decision models, along with appropriate interpretations, discussions of assumptions, explanations of foreseeable limitations, and whether the presented decision models present conflicting recommendations.
Engineering Economy
ISBN: 978-0132554909
15th edition
Authors: William G. Sullivan, Elin M. Wicks, C. Patrick Koelling