Brown-Forman has just spent $45m building a new distillery to house the Old Forester brand, and is finally ready to celebrate its grand opening this summer.
The new distillery has a production capacity of 6,000 barrels of whiskey/year, more than twice what is required to support current sales, and management intends to shift all future production of Old Forester branded whiskey once it opens.
Proposal: The company intends to celebrate this grand opening by producing a new line of whiskey made from one of the Brown family’s original recipes, launching a new line of “premium” whisky that will help invigorate the brand.
The Brown family insists that this whiskey must be aged for at least 10 years, believes that it can be sold at a wholesale price of $30/bottle.
Project Details
Initial Production Costs: $600/barrel
Expected production: 300 barrels per year
The company intends to age the whiskey for 10 years by placing it in a warehouse; during that time, the whiskey will change flavor as it gradually evaporates and begins to chemically interact with the barrel.
Storage costs are expected to be $50 per barrel for each year that the whiskey is in storage, and the company believes that it will be able to resell each barrel for $200 when ageing is complete.
At the end of the 10 years, the company will remove the whiskey from storage and transfer it to bottles. Over 40% of the original whiskey will have evaporated by that point, but there will be enough left to produce 160 bottles from each barrel.
At this point, the company expects to pay bottling and labeling costs of $2 per bottle; excise taxes of $3 per bottle; and marketing costs of another $3 per bottle. It plans to sell this whiskey at a wholesale price of $30 and expects its average tax rate to be 21%.
The company plans to produce this whisky for the next 20 years, and all costs and prices given are inflation adjusted.
Assignment ( Excel )
Help management decide whether to produce this whiskey!
Estimate the cash flows associated with this project and determine what Brown-Forman’s required return ought to be.
Calculate both its NPV and MIRR, taking the following issues into account:
Issue #1: The evaporation rate of whiskey can be difficult to predict. Our estimates about the quantity of whiskey each barrel can produce may be off by +/- 10%.
Issue #2: Our pricing assumptions may be wrong! The wholesale price of this whiskey could be anywhere from $24-$36 dollars depending on its quality, and the market environment.
Should Brown-Forman produce this whiskey? Write a brief memo to management summarizing your analysis.
A complete assignment must address several questions:
What should Brown-Forman’s required return be on this project?
How much value will this project create for the company, and is its expected return high enough to justify the investment?
How have you handled inflation in your analysis?
How did you use sensitivity analysis and/or scenario analysis to stress-test your assumptions, and did this analysis affect your results?
What is the minimum price at which Brown-Forman should be willing to sell this whiskey?