1) As a senior vice president of a major consumer products corporation, you have been asked to review the following investment and advise the CEO whether it should be pursued. The investment involves buying a bottle manufacturer and making it a subsidiary of your beer division. The acquisition will benefit the firm by providing a reliable internal source of bottles. The acquisition price will be $3,500,000. The bottle company has tangible assets of $2,500,000 and debt of $1,000,000 which must be paid off by the parent corporation (for a total of $4,500,000 in cash outlays). If the transaction occurs, the beer division will also acquire an intangible asset of $2,000,000 to reflect the premium paid for the bottler. That intangible asset must be amortized over five years, resulting in an expense of $400,000 per year. The company will also have depreciation expense of $200,000 per year for the next ten years on the bottler’s property, plant, and equipment. No new equipment will need to be purchased during the operating life of the bottling plant. The company would have to make some changes at the bottling plant in the first year following the acquisition to optimize it for producing bottles for its beer plant. Those changes will cost $300,000 (and will be expensed immediately).
On the plus side, the bottling plant will produce 20 million bottles per year at a variable cost of $0.12 per bottle and a fixed outlay cost of $1,500,000 per year. Currently, the beer division pays $0.25 per bottle and has sufficient volume that it can use as many bottles as the bottling plant can produce. The bottling plant is expected to operate for ten years following acquisition before it becomes obsolete. At that point, it can be scrapped and the land sold, yielding $1,000,000 (received in December 2028), for a gain on sale of $500,000.
If the firm buys the bottler, the transaction will take place on December 31, 2018, with the new operations affecting the company starting in 2019. By convention, costs and benefits received throughout a year are treated for present value purposes as occurring at the end of that year. There are no taxes and the firm’s discount rate is 10 percent.
Determine the net present value and NPVI for the corporation if it buys the bottling company. (Use 2018 as year 0.)