Question

20. Sleeman Brewery is considering adding a new line of craft beers to its product mix. The new beer will require additional brewing and bottling capacity at a cost of $35 million. The new line of craft beer is expected to generate new sales of $20 million per year and free cash flow of $10 million for the next 5 years. After 5 years, competition is expected to reduce sales and cash flows to Nil. If the brewery has a cost of capital of 10%, what is the Net Present Value (NPV) of this investment for Sleeman?

Answer 1

For calculating the NPV of this project, we will take into consideration the free cash flows from the project not the sales. Free cash flows are cash flows after consideration of different expenses like tax and depreciation.

So free cash flows of 10 millions for 5 years will be discounted using the cost of capital of 10% and if it exceeds the cash outflows of $35 millions , the project is to be accepted else not.

It is assumed that cash outflows is related to beginning of year and cash inflows start to accrue from end of first year.

So NPV = [-35+ (10/1.1)+(10/1.1^2)+(10/1.1^3)+(10/1.1^4)+(10/1.1^5)]

= (-35+9.09+8.26+7.51+6.83+6.20)

= (-35+37.89)

= $2.89 Millions.

So Net present value of the project is $2.89 Millions and hence rhe project should be accepted.