Annual Cash-Flow Estimation And Assumptions Case Studies Examples

Investing In a Brewpub: A Capital Budgeting Analysis

Investing In a Brewpub: A Capital Budgeting Analysis

Initial investments include the following (Table 1)
Capital Investments for the project “Investing in a Brewpub”
Note: Data taken from Investing in a Brewpub: A Capital Budgeting Analysis. International Research Journal of Applied Finance (2013)

On the last period, the Brewpub is sold for $20,000 (estimated recovery value)

The change in working capital refers to amount spent on inventory and receivables at the initial period of the project and later on recuperated at the 10th year.
Sales in “best case scenario” are 7 barrels per set a year which equate to a total of 560 barrels or 138,800 pints a year at $5 the first year and 3% increments on each of the following years
Variable costs include the cost of ingredients to make the beer which are $4,000 for 10 barrels a year and has 5% increment each year.

Fixed Costs include (Table 2):

Fixed Annual Costs for the project “Investing in a Brewpub”
Note: Data taken from Investing in a Brewpub: A Capital Budgeting Analysis.
International Research Journal of Applied Finance (2013)
In fixed costs, brewpub maintained cost begin from the second year onwards, salaries and wages of employees increase 3% year, and insurance increases 5% on year 5 and remains constant later on. Depreciation is added on fixed costs in order to calculate tax, and is later on added to the project as cash didn't went out of the company

Tax is 30% of Sales minus fixed and variable expenses (including depreciation).

Depreciation is included on Fixed Cost in order to calculate taxes and is later on re-added on the cash-flow since it doesn't represent an expenditure in which cash was given away.

Sunk costs of $2,000 of market research wasn't taken since this was incurred already and doesn't, therefore, affect the investment decision.

No interest nor debt is considered as the case didn't talk about them incurring in debt, so equity investment is assumed.

The Cash-flow is presented in the following page (Figure 1)

Figure1

Cash-Flow of project “Investing in a Brewpub”

Note: Cash-flow was estimated using data from Investing in a Brewpub: A Capital Budgeting Analysis. International Research Journal of Applied Finance (2013)

NPV and IRR

Taking the cash-flow above and using the respective formulas, the NPV and the IRR are as follows (Table 3):
NVP and IRR of project “Investing in a Brewpub”
Note: NVP and IRR calculated using data from Investing in a Brewpub: A Capital Budgeting Analysis. International Research Journal of Applied Finance (2013)
According to the best case scenario, Samantha and Grant should go ahead with the Brewpub because the NVP is positive which means it is viable and profitable with a number close to $500,000, and the IRR is 22% exceeding their cost of capital which means that even if they loaned money from their bank for the project, they would still have profit left for them.

Worst Case Scenario

The following would be the cash-flow (Figure 2) in the worst case scenario in which sales and variable costs (and tax accordingly) would be reduced since they are calculated based on 5 barrels sold a year per seat.
Figure 2

Cash-Flow Worst Case Scenario project ““Investing in a Brewpub”

Note: Cash-flow calculated using data from Investing in a Brewpub: A Capital Budgeting Analysis. International Research Journal of Applied Finance (2013)

Given the fact that future cash-flows decreased, NPV and IRR also decreased (Table 4)

NVP and IRR of project “Investing in a Brewpub”
Note: NVP and IRR calculated using data from Investing in a Brewpub: A Capital Budgeting Analysis. International Research Journal of Applied Finance (2013)
In the worst case scenario, the NVP is negative which means the project isn’t viable and shouldn’t be done. The IRR is very low and it isn’t worthwhile taking into account the cost of capital.

Renovations, Increase Pint Price and Impact on NVP and IRR

If a capital expenditure is made at the 5th year of $1 million to renovate the restaurant and the price of the beer is increased on year 5 to $7 and remains at that price until the end of the project, the following cash-flow results (Figure 3)
Figure 3

Cash-Flow Best Case Scenario, renovations, increase price, project “Investing in a Brewpub”

Note: Cash-flow calculated using data from Investing in a Brewpub: A Capital Budgeting Analysis. International Research Journal of Applied Finance (2013)
In this case, the NVP (Table 4) is positive and over $100,000 which means the project is worthwhile pursuing. The IRR is 12% above their cost of capital which is also a good sign indicating the project is profitable and they can lend money and pay interest and still make profit out of it.
NVP and IRR of project “Investing in a Brewpub”
Note: NVP and IRR calculated using data from Investing in a Brewpub: A Capital Budgeting Analysis. International Research Journal of Applied Finance (2013)

Change in Cost of Capital and its Impact on Investment Decision

An increase in the cost of capital will lower the NP. When the cost of capital and the IRR are equal the NVP is 0 and the project isn’t worth doing since it will not give profit. When the cost of capital is greater than the IRR, then the NVP is negative which means that they will incur in losses were they to pursue the project. The following table (Table 5) illustrate the change in the NPV with different values of cost of capital:

NVP and IRR Scenarios different cost of capital of project “Investing in a Brewpub”

Note: NVP and IRR calculated using data from Investing in a Brewpub: A Capital Budgeting Analysis. International Research Journal of Applied Finance (2013)

Other Issues Influencing Decision and Issues not considered by Samantha and Grant in this project.

Issues that can affect their decision is fund availability. The project requires a high initial investment which they may or may not have, and banks and financial institutions may not lend them enough money for it. Without the funds, the project can be undergone. Also, they didn’t take into account inflation and how it affects also fixed prices as they were assumed to remain constant throughout the whole 10 years. In real life, utility, rent, etc. can go up and affect the cash-flow of the project. The couple didn’t take into account also an average scenario which is the most likely to happen, not the best or worse so they can base their decision on a more realistic picture.

References

Ehrhardt, Michael (2014) Corporate Finance: A Focused Approach. Mason, Oh: South-Western.
Cengage Learning.
Brealey, R., Myers, S., Marcus, A. (2001) Fundamnetal of Corporate Finance. Third Edition.
Mason, Oh. McGraw Hill Publishing.