Question

You plan to open your own wine business. The cost of plant, property and equipment is $500,000. You already have the money for the initial cost which you could invest at the same level of risk and expect to earn 10%. You think you can sell 1 million bottles/year at $1/per bottle. Your costs are $200,000/per year to keep the factory running plus $0.50/bottle produced. Your tax rate is 50% and you plan to operate this business for 5-years. You plan to depreciate on a straight line basis to a book value of zero and the salvage value is expected to be zero. If you don’t start a wine business you plan to keep working at your current job that pays $75,000/year
(pre-tax, you would have to pay 50% tax on this income). What is the NPV of opening the wine business?

Answer 1

Sales [1000000*1]	$    10,00,000
Production cost [1000000*0.5]	$      5,00,000
Other production costs	$      2,00,000
Depreciation [500000/5]	$      1,00,000
Net operating income	$      2,00,000
Less: Loss of income from job [opportunity cost]	$ 75,000
Incremental NOI	$      1,25,000
Tax at 50%	$ 62,500
Incremental NOPAT	$ 62,500
Add: Depreciation	$      1,00,000
Incremental OCF	$      1,62,500
PV of incremental OCF = 162500*(1.1^5-1)/(0.1*1.1^5) =	$      6,16,003
Less: Initial invesment	$      5,00,000
NPV of the wine business	$      1,16,003