Spencer D.

Pogue

Investing in a Brewpub: A Capital Budgeting Analysis

1. Estimate the Operational Cash Flows for the brewpub project. Use the
best case and worse case scenarios. To do this, you will need to
calculate the annual revenues and annual expenses for the 10-year
project, any changes in net working capital, and any changes to capital
expenditures. Describe all assumptions and calculations you used to
arrive at the final free cash flows.

This case study should have been set up as a pro-forma income

statement. First the onetime cost are not a onetime cash outlay by the
owners. Remember, they will be taking out a loan for the onetime cost.

Than the brewpub equipment and construction cost should be

depreciated. The onetime license fee and web design should be
amortized.

The interest on the loan should be included as an expense.

Once you calculate Net Income then you add back depreciation to get
to operating cash flow.

*See Spreadsheets attached

2. Calculate the NPV and IRR of the project given the information presented
using the best case scenario. Should Samantha and Grant go ahead with
the brewpub investment? Why or why not?

NPV = $1,450,092
IRR = 51%

Net present value is positive, meaning the cash outflows for this
project is less than the cash inflows. The required rate of return
(cost of capital) is 8% and the IRR for this project is 51%, more than
the require rate of return. Grant and Samantha should proceed with
the project.

Using the operating the operating cash flow you calculate NPV using an 8%
discount rate. From that you calculate IRR. IRR should be around 24%
3. What would be the impact on NPV and IRR if the worst case scenario
occurs? Would this alter Grant and Samanthas decision whether to invest
in the brewpub? Describe how you found this result (also show in
the spreadsheet).

In the worst case scenario I adjusted the annual revenue down from
$694,880 (7bbl sold) to $496,000 (5bbl sold). This made the
variable expenses increase (wages/salaries) therefore adjusting the
NPV down to $504,613 and IRR down to 27%. They still should
proceed with the project since NPV is positive and IRR is greater
than the required rate of return of 8%.

The worse case should produce an IRR below the cost of capital.

4. Suppose they are operating under the best case scenario and they
decide that in year 5 they would like to do major renovations to the
restaurant (a capital expense). They figure this will cost an additional
$1,000,000 in year 5. Along with the renovations, they figure they could
increase the price of the beer to $7 per pint and keep it at that price for the
duration of the project. How do these changes impact NPV and IRR? Is
it worth it for the pair to go forward with the renovations? Describe how you
found this result (also show in the spreadsheet).

I adjusted the annual revenues in year 5 to $972,160 to account for

the $2 price increase on the beer while still keeping the 3% increase
each year. I added $1MM (Capital Purchase) to account for the
renovation. In my capital analysis spreadsheet, I adjusted the year
5 growth rate percentages to adjust the operating cashflow outputs
in my spreadsheet.

Doing a $1MM renovation in year 5 changes the NPV and IRR

dramatically. Post-renovation the NPV drops to $11,302 and the IRR
drops down to 9.76%. Although still positive, Grant and Samantha
would not want to eliminate all of their profits for a renovation that
will not yield them any returns compared to Pre-renovation.

The $1M should be depreciated, not take as a one time cost.

5. Would there be a significant impact to Samantha and Grants

brewpub decision if there were a change in the cost of capital? Describe how
you found this result (also show in the spreadsheet).
Changing the cost of capital to 15% and adding an additional fixed
expense of $300,000 changed the NPV to ($65,698) and made the
IRR decrease to 12.97%.

6. Are there any other issues that you think might influence the pairs
investment decision? What, if anything, have Samantha and Grant
not considered in their capital budgeting analysis?

They could try to finance the project with a loan instead of using all
equity, this way some of the interest may have tax benefits.

*I color coded my answers to help match the corresponding spreadsheets to

the answers.