Cash Flow Estimation and Risk Analysis

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CASE 2

Cash Flow Estimation and Risk Analysis

Robert Montoya, Inc.

Robert Montoya, Inc., is a leading producer of wine in the United States. The firm was founded in 1960 by Robert Montoya, an Air Force veteran who had spent several years in France both before and after World War II. This experience convinced him that California could produce wines that were as good as or better than the best France had to offer. Originally, Robert Montoya sold his wine to wholesalers for distribution under their own brand names. Then in the early 1960s, when wine sales were expanding rapidly , he joined with his brother Marshall and several other producers to form Robert Montoya, Inc., which then began an aggressive promotion campaign. Today,
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(Hint: Use Table 1 as a guide)

5. Estimate the project’s operating cash flows. (Hint: Again use Table 1as a guide) What are the project’s NPV, IRR, modified IRR (MIRR), and payback? Should the project be undertaken?

6. Now suppose the projects had involved replacement rather than expansion of existing facilities. Describe briefly how the analysis has to be changed to deal with a replacement project.

7. A. Assume that inflation is expected to average 5 percent per year over the next 4 years. Does it appear that the project’s cash flow estimates are real or nominal? That is are they stated in constant (Current year) dollars, or has inflation been built into the cash flow estimates? (Hint: Nominal cash flows include the effects of inflation, but real cash flows do not.)

B. Is the 10 percent cost of capital a nominal or a real rate?

C. Is the current NPV biased, and, if so, in what direction?

8. Now assume that the sales price will increase be the 5 percent inflation rate beginning after Year 0. However, assume that cash operating costs will increase by only 2 percent annually from the initial cost estimate, because over half of the costs are fixed by long-term contracts. For simplicity, assume that no other cash flows (net externality costs, salvage value or net working capital) are affected by inflation. What are the project’s NPV, IRR, MIRR, and payback now that inflation has
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