Use the following to answer questions: Homy Brew Whiskey (HBW) is developing a new whiskey line that
Question:
Use the following to answer questions: Homy Brew Whiskey (HBW) is developing a new whiskey line that they expect the annual sales of 52,000 bottles in year 1. Sales volume will increase by 2% per year until year 5. The selling price is $85, and the variable cost is $35 per bottle, which will stay the same in the next five years. There is a fixed production cost (exclude depreciation) of $1.5 million per year. The operating expense is equal total VC plus fixed production cost. The new product will require a replacement of an existing production line with a new line today that has a greater output capacity than the existing line. The new line would cost $3.5 million, have a five-year life, and would be depreciated using MACRS over three years. At the end of five years, the new line has no salvage value and will be discarded. If HBW invests in the new line, a one-time investment of $22,000 in additional working capital will be required. The tax rate is 35%. The product line is going to be financed with 65 percent debt and 35 percent equity. The pretax cost of its debt is 8.45 percent. The shareholders invested to this product line expect such equity investment to have a beta of 1.7, the risk-free rate of return is 4 percent and the market risk premium is 6 percent.
Questions: 1. Compute the required return from equity E(R.) using CAPM model.
2. Compute the discount rate using WACC model.
3. Prepare a template and compute all necessary components to calculate free cash flows from this product lines each 5 years. Then calculate free cash flows. (5 ) (*)
4. What is the NPV of the new production line? Should the company proceed with this project? Why?
5. What is the IRR of the new production line? Compared to the cost of capital, should the company proceed with this project?
6. Compute the payback period of the new product line. If the cutoff period is 4 years, should the company proceed with this product?
7. Compute EBITDA break-even and EBIT break-even points. Interpret the results .
Formulas required to answer all questions. (*) Formulas should be listed out in the footnote
Fundamentals of corporate finance
ISBN: 978-0470876442
2nd Edition
Authors: Robert Parrino, David S. Kidwell, Thomas W. Bates