Adams Wineries, Inc. (B)
In Case 15, Jean Resce, the financial vice president, analyzed a light wine project for Adams Wineries. The project required an initial investment of $600,000 in fixed assets(including shipping and installation charges), plus a $20,000 addition to net working capital. The machinery would be used for 4 years and would be depreciated on the basis of a 3-yeat MACRS class life. The appropriate MACRS depreciation allowances are 0.33, 0.46, 0.15, and 0.07 in Years 1 through 4, respectively. If the project s undertaken, the firm expects to sell 200,000 bottles of wine at a current dollar (Time 0) wholesale price of $4 a bottle. However, the sales price will be adjusted for inflation, which is expected to average 5 percent annually, so the actual expected sales price during the first year is $4.20, the expected price in the second year is $4.41, and so on.
The light wine project is expected to reduce the before-tax profit Adams currently earns on its wine cooler line by $20,000, because the two product lines are somewhat competitive. Further, the company expects cash operating costs to be $3 per unit in Time 0 dollars, and it expects these cost to increase by 2 percent per year. Therefore, total variable cost during the first year of operation (Year 1) is expected to be ($3.00)(1.02)(200,000) = $612,000. Adams’ tax rate is 40 percent, and its cost of capital is 10 percent. Selected cash flow data and other information as developed by Resce, using a Lotus 1-2-3 model, are given in Table 1
When Resce and her assistant presented their analysis to Adams’s executive committee, things went well, and they were congratulated on both their analysis and their presentation. However, several questions were raised. In particular, the executive com ...