Capital City Brewery (CCB) brews three different types of beers from their brewpub and restaurant in downtown Springfield. They have been receiving a lot of pressure from their 10 private investors to either reinvest their $300,000 of cash on hand back into the business or return it to investors in form of a dividend. Management has hired you to evaluate three projects for them:
1. $150,000 expansion of their exiting brewery capacity to purchase new equipment that would allow them to produce three additional flavors of of beer. The marketing folks have projected these new beers to bring in about $10,000 in new cash over the first year in production, then growing at 50% for year 2 and another 50% in year 3, and then 20% growth rate in years 4 and 5 before reaching capacity at the end of year five.
2. $500,000 purchase of new property restaurant on the west side of Springfield where they could sell more of their exiting beer, along with their specialty line of horse shoe entrees and other foods. Margins at this more upscale-imaged restaurant are projected to be higher. Operating projections for the first year show the company losing $25,000, but spinning off positive cash of $25,000, $75,000, $125,000 and $150,000 for the following 4 years respectively. The bank has agreed to loan up to $250,000 on this purchase at a rate of 5% for the next five years.
3. It has been rumored that CCB’s largest local competitor--Bruce’s Brews (BB)—would be interested in selling. While CCB has been growing, BB seems to the hold about 50% of the local craft beer market, where CCB holds about 25% of the market. An insider at BB has recently revealed that BB net earnings last year was right at $150,000. This same insider assured you that BB's sole owner would sell at the right price.
Evaluate the present value of each of the above alternatives and recommend to management what you think they should do, including a fourth option of returning the cash to shareholders through a dividends.
Show your work for each alternative. A couple of items to consider for your evaluation:
Cost of Capital -- You get to determine it, it is not given. Each alternative may have different risk profiles. Consider the risk profile and investors expected rate of return when you compare the alternatives against giving back the cash to investors.
Net Present Value -- determine it for all alternatives
Payback Period -- Try and compute that for all three alternatives
Present Value of Bruce's Brew -- You will need to determined that in order to compare with other alternatives. You may need to make some assumptions on how to determined this value. State any assumption and support it with data when possible.