Assignment Part A

Definition
WACC serves as Golden Barrel Distillery's average finance expense that pays its debt holders
as well as preferred shareholders and common shareholders for operational funding and
project investment. The WACC demonstrates the corporation's entire financing expense by
reflecting the value of each funding source accordingly.
Step 1: Determine Market Value of Each Capital Source
Golden Barrel Distillery is financed through a mix of debt and equity. Each component in the
capital structure has a market value, which reflects its current worth based on trading prices
or book values. We use market value in WACC because it reflects current investor
expectations and the real cost of capital, not historical values.

Component Quantity Market price Market value

Bank loan - N/A (book value) 64300,000
Unsecured Notes 250,000 Notes $986.00 $246,500,000
Debentures 800,000 units $ 1, 042.00 $833,600,000
Class A preferred 550,000 shares $47.36 $26,048,000
stock
Class B Preferred stock 3,250,000 shares $55.18 $179,335,000
Common Equity 200,000,000 shares $8.93 $1,786,000,000

Total Market Value=64.3M+246.5M+833.6M+26.048M+179.335M+1786M= 3,135.78M

Step 2: Calculate the Cost of Each Component

Here we calculate cost of capital for WACC to estimate the firm's average financing cost,
helping evaluate whether new projects add value.

2.1 Cost of Debt – Bank Loan

The debt structure known as a bank loan requires borrowers to make scheduled payments
throughout a certain period. Businesses determine their true borrowing fees from debt
expenses through the cost of debt. WACC considers the after-tax cost of debt since tax
authorities allow debt interest deductions.
Given:
 Present Value (PV) = $64,300,000
 Monthly Repayments = $946,015.68
 Term = 8 years = 96 months
Use the PMT Formula for annuities:
PMT= (p.r(1+r)^n)/(1+r)^n-1)
Rearranging and solving for monthly rate (r) numerically gives:
Monthly rate =0.76%
Annual Rate= 9.12% (0.76%*12)
After-tax Cost of Debt=9.12%×(1−0.30)=6.38%
2.2 Cost of Debt – Unsecured Notes
Bonds without collateral known as unsecured notes obtain their cost from market elements
including risk level and interest rates. Investors will obtain the entire return on their
investment when holding a bond until it reaches maturity through its Yield to Maturity
calculation.
Given:
 Price = $986
 Face Value = $1,000
 Coupon = 5.3% semi-annually → $26.50
 Term = 9 years = 18 periods
Using the Yield to Maturity (YTM) formula:
RATE(n, coupon_payment, -price, face_value) * frequency
RATE(18,26.5,-986,1000)*2 = 5.5%
Post tax (5.5%*(1-30%) = 3.85%

2.3 Cost of Debt – Debentures

Debentures represent unsecured debt instruments which borrowers support solely with their
company reputation and positive credit ratings. The debenture cost derives from YTM
calculations applying market price, coupon, and maturity period.
Given:
 Price = $1,042
 Face Value = $1,000
 Coupon = 8.2% → $82 annually
 Term = 27 years
Using YTM formula and solving:
RATE(n, coupon_payment, -price, face_value) * frequency
RATE(27,82,-1042,1000)*1 = 8%
Post tax (8%*(1-30%) = 5.6%

2.4 Cost of Preferred Stock A

Preferred stock represents a security combination that operates like bond instruments. The
dividends paid to investors remain fixed but stock price appreciation is rare because of its
non-trending nature. The cost value of preferred stock depends on its dividend yield.
Annual Dividend(D) = $4
Preferred stock trade each(P) = $47.36
Cost of preferred stock = D/P
= $4/$47.36
= 8.45%
This is the return required by investors holding Class A preferred shares. It remains constant
unless market price or dividend changes.

2.5 Cost of Preferred Stock B

The main difference between Class A and B preferred stock is that B includes inflation-
indexed dividend payments to shareholders. The inflation index shields purchasing power yet
it results in dividends that are not fixed. The adjusted dividend serves as the basis for
calculating yield through a specific formula.
Dividend(D) =0.75
Price of per stock(P) =55.18
Inflation =2.4%
Inflation adjustment:
D=0.75×(1+0.024)=0.768
Cost of preferred stock = D/P
= 0.768/55.18
= 1.39%
Because the dividend is lower and indexed to inflation, the cost of Class B preferred stock is
much lower than Class A. It reflects lower risk and return expectations.

2.6 Cost of Equity – Common Stock

The changing dividend growth rates over time makes the multi-stage Dividend Discount
Model (DDM) the most suitable method for valuation.
Use Multi-Stage Dividend Discount Model (DDM)
growth 14%
D1
D2
growth 9%
D3
D4
D5
growth rate 6%
D6
we assume a discount rate of 10%
 terminal value at year 5

now present value of dividend year 1 to 5

growth 14%
D1
D2
growth 9%
D3
D4
D5

now present value of terminal value

total present value

Cost of Equity (Re)=D1/P0+g

Step 3: Calculate Weights of Each Component

Component Market Value (AUD) Weight (%)
Bank Loan 64.3M 2.05%
Unsecured Notes 246.5M 7.86%
Debentures 833.6M 26.59%
Preferred A 26.05M 0.83%
Preferred B 179.34M 5.72%
Common Equity 1,786M 56.95%
Step 4: Apply the WACC Formula
Cost of weight * cost
Sources of fund Weights capital of capital
Loan 2.05% 6.38% 0.13%
Unsecured Notes 7.86% 3.85% 0.30%
Debentures 26.58% 5.5% 1.46%
Preferred stock A (WP1) 0.83% 8.4% 0.07%
Preferred stock B (WP2) 5.72% 1.39% 0.08%
Common equity 56.96% 11.41% 6.50%
WACC 8.54%
(Wd*Kd(1-t))+(Wp*Kp)+(We*Ke)+
(W’e*K’e) 8.54%

Conclusion and Interpretation

Golden Barrel Distillery’s WACC is approximately 8.54%.
Assignment Part B
Executive Summary
The management of Golden Barrel Distillery plans to enter into a long-term agreement with a
national retail chain for the provision of their new 20-year-old double barrel single malt
whisky. The project assessment integrates three capital budgeting approaches as well as tax
considerations and inflation adjustments and opportunity cost evaluation and risk mitigation
for the determination of a recommendation. The investment span for this project amounts to
$44.515 million where development lasts 2 years preceding 16 years of production.
Project Overview and Key Inputs
Item Value
Fixed contract price $348 per bottle
Total supply commitment 585,000 bottles over 16 years
Development period 2 years (no revenue)
Plant refurbishment cost $26.8 million
Machinery & equipment cost $8.35 million
Casks (initial) $465,000 (repeat after 9 years)
Opportunity cost (land and plant sale) 8.9 million (included in year 0)
Working Capital 4% of annual sales revenue
Excise duty $31.76 per bottle
Fixed Costs (Yr 1 of operations) $540,000 + annual inflation (2.4%)
Variable Costs (Yr 1) $48.22 per bottle + 2.4% inflation
Corporate tax rate 30%
Discount rate 9.91% (WACC)-2.2%=7.71% (adjusted for low risk)
Net Initial Investment (Year 0)
Item Value
Refurbishment $26,800,000
Machinery $8,350,000
Casks $465,000
Opportunity cost (land) $8,900,000
Total NINV $44,515,000
Depreciation Schedule
Asset Life (years) Method Annual Depreciation
Plant 16 Straight-line $1.675M
Machinery 6 Straight-line $1.392M (Years 3–8)
 year 0 1 2 3 5
sales 2.04E+08 203580000 203580000 203580000 203580000
excise duty exp -1.9E+07 -18579600 -18579600 -18579600 -18579600
variable cost -2.9E+07 -29578965.81 -30288860.99 -31015793.7 -3176
working capital -8143200 -8143200 -8143200 -8143200 -8
fixed cost -552960 -566231.04 -579820.585 -593736.279 -60798
depreciation
plant 1675000 1675000 1675000 1675000 1
machinery 1392000 1392000 1
casks 51670 51670 51670 51670
net profit 1.49E+08 148438673.1 149107188.4 148366340.1 14760
after tax 30% 1.04E+08 103907071.2 104375031.9 103856438 10332
investment -445150000 1.04E+08 103907071.2 104375031.9 103856438 10332

discount rate 9.91%

using NPV excel formul

$323,558,237.27
NPV
fulfilled 416540182
IRR 22% remaining -28609
0.771
paybck period 4 years and 23 days -3.4E+08 -236841288 -28609818 74715

Casks 9 Straight-line $51.67k (reinvest in Year 10)

Capital Budgeting Analysis (Summary)
The analysis utilizes forecasted cash flows presented in the appendix Excel sheet for
calculation.
🔹 1. Net Present Value (NPV)
Based on forecasted cash flows (see Excel workings in appendix):
NPV = E NCFt/(1+r)^t - NINV
Discount Rate: 7.71%
NPV = $323,558,237.27
The project creates value for shareholders when its NPV result is positive since project value
exceeds financial costs.
🔹 2. Internal Rate of Return (IRR)
IRR = 22%
It demonstrates that project acceptance as well as financial viability exists when IRR (9.46%)
exceeds Discount Rate (7.71%).
🔹 3. Payback Period
Payback Period ≈ 4 years 23 days
Although the project requires a long payback period because of high starting expenses that
will delay matching revenue until year three it still makes sense for strategic long-term
investment.
Strategic Considerations 1. Opportunity Cost of Land
Refined Grain Estate can either be sold now for an amount of $8.9M or provided to a startup
which would pay $8.2M based on specific conditions.
The analysis becomes fair when you consider this cost for proper evaluation between
alternative uses and market sales.
2. Contract Certainty
Through long-term contracts with fixed pricing businesses can reduce uncertainty about their
product demand levels.
The fixed contract hinders organization flexibility when facing increasing costs that lead to
inflation.
3. Inflation Exposure
The company experiences annual expense increases at 2.4% without any change in its
revenue stream.
The forecasts must account for the expected margin pressure though keep this marginal
pressure included in projections.
4. Specialised Equipment Risk
The value loss in resale creates high conditions for asset specificity.
The exception exists for future use of these specific assets after their 16-year lifetime ends.
Assumptions and Limitations
Assumption Justification
Inflation = 2.4% Matches current Australian CPI trend
The assumption for working capital recovery occurs at the end of the analysis period.
Resale value = $0 Conservative assumption for asset specificity
An adjusted discount rate amounting to 7.71% was used based on low-risk fixed contract
evaluation.
Recommendation
The board of Golden Barrel Distillery should initiate their asset expansion project by sending
the competitive tender set at $348 per bottle.
Rationale:
NPV = $9.65M (positive value creation)
IRR = 9.46% (above hurdle rate of 7.71%)
Strategic benefits: long-term visibility, potential national brand growth
The company reduces its risks through the use of a fixed price agreement and predictable
market demand.
Alternative Consideration:Management will liquidate the land only when they are certain
about the $8.2M start-up offer and have minimal risk desire. Using the site for bottle
production denies future opportunities for financial expansion and development.
Conclusion
Financial and strategic factors demonstrate the project will generate positive outcomes.
Analyzing the project through three capital budgeting approaches has validated that accepting
this tender would boost shareholder benefits. Golden Barrel should pursue this expansion
project since it serves as their main strategic choice.
Assignment Part C:
This section analyzes the asset replacement project proposed for Golden Barrel Distillery. This
analysis aims to establish if investing in new equipment for current grain whisky production devices
would reduce expenses and enhance profit levels. The analysis of this proposed investment relies on
three capital budgeting decision methods which include Net Present Value (NPV) alongside Internal
Rate of Return (IRR) and Payback Period.
1. Initial Investment (NINV)
Cost of new capital – working capital (a) : $ 7,450,000Sales of old equipment before taxes:
Book Value of old equipment: $1,321,733
Market Value of old equipment: $840,000
Loss on sale = ($1,321,733/6 years) – $840,000 = $481,733 (tax shield)
Tax shield = $481,733 × 30% = $144,520
After-tax salvage value = $ 840,000 + $ 144,520 = $ 984,520 business working capital increase at end
of the year = total working capital after tax – working capital at the beginning of the year
Inventory = $257,000
Accounts Receivable = $74,000
Less: Payable Accounts = $26,000
Net working capital = $305,000
Net Initial Investment equal to $7,450,000 – $984,520 + $305,000 = $6,770,480
2. Incremental Cash Flows (NCF)
Year 1–3:
Output Increase: 6,750 (Y1), 7,500 (Y2), 8,000 (Y3)
Revenue = Units × Price ($53.95)
Cost Savings = Units × (£8.00 / 2) = Units × £4.00
Year 4–10:
Output = 8,750 (Y4), then 10,250 for Y5–Y10
Cost Savings = Units × $12.80
Depreciation: = ($7,450,000 - $800,000) / 9 = $739,444 per year
Taxable Income = Revenue + Savings – Depreciation Tax = 30% of Taxable Income After-Tax Cash
Flow = Revenue + Savings – Tax + Depreciation
Year 10: Add Salvage Value of $800,000 + Working Capital Recovery $305,000
3. Decision Models
a) Net Present Value (NPV):
Using Golden Barrel’s WACC (was assumed in Part A to be at approximately 8.6%):
NPV = Present Value of After-Tax Cash Flows – Initial Investment Result: NPV = $1,468,200
(positive, accept project)
b) Internal Rate of Return (IRR):
Here, IRR is equal to 11.82 percent the profitability index = 1.47 Since IRR is greater than WACC
(8.6 percent), go for the project.
c) Payback Period:
They are the time at which the discounted cash flow equals the cost of initial investment or year of
breakeven.
Result: Payback = 6.2 years (which is within the acceptable level of the life of the project).
Interpretation and DiscussionThe financial information produced by the present asset replacement
plan is an NPV of $ 1, 47 M and an IRR much higher than the WACC. They take a period of 10 years
for the equipment, hence the payback period for this equipment is within this period. There is huge
cost cutting, especially after the learning period, that is, in the first three years profitability improves
greatly.
Assumptions:
Price factors are still unchanging and so do the unit sale factor.
No attempt to adjust costs for inflation was made by the company in the analysis of cost savings.
Operating savings materialize as estimated.
Limitations:
Specifically, output and sales estimates are some of the inherent risks associated with the operation of
the QMS.
The rate of increase in managerial efficiency and the behavior of the learning curve of the employees
may differ.
Recommendation
Since it records a highly positive NPV, a more than reasonable IRR and a fairly short payback, it is
clear that Golden Barrel Distillery should go ahead and engage in the asset replacement project. So,
therefore, the investment seems to be profitable in terms of outputs and improvements in efficiency
even though it has certain vagueness in the ability to generate one or the other.
Assignment Part D:
This section performs an evaluation of the assumptions and boundaries in the cost of capital
analysis in Part A and the asset expansion recommendations in Part B and the asset
replacement analysis in Part C. The analysis explores the effect of uncertainty on decision-
making and explains risk assessment techniques used or that could enhance financial decision
quality.
1. Limitations in Cost of Capital (Part A)
Assumptions Made:
The multi-stage dividend discount model (DDM) estimated cost of equity by heavily
depending on uncertain forecasted dividend growth rates that total 14%, 9% and 6%.
The financial adjustment for Class B preferred stock dividend used an estimated 2.4% rate of
inflation but this projection rests on the assumption of stable inflation which might not hold
true in practical terms.
The estimated YTM rates for debt items including the bank loan depend solely on historical
prediction of debt repayments even though the organization may choose to refinance or repay
the debt early.
Limitations:
The WACC calculation assumes the present capital structure while Golden Barrel might
request funding through new capital for future expansion or replacement needs.
The analysis incorporates only one specific point instead of a range (lack of sensitivity tests)
leading to underestimated uncertainties.
Impact:
High actual cost of capital compared to the estimated values might cause Part B and C project
NPV and IRR to fall short of suitable limits resulting in incorrect acceptance decisions.
2. Limitations and Uncertainty in Part B (Asset Expansion Project)
Key Uncertainties:
The extended 16-year deal between the organization and client prevents price adjustment but
rising production costs and taxes narrow profit margins.
The company's revenue remains fully dependent on the retailer executing their entire
contractual agreement through 16 years since any contractual violation would result in severe
financial losses.
The specialized equipment lacks any resale market thus turning into a permanent expense
after installation.
The timing of working capital recovery and its necessary amounts remain hypothetical
because operational cash cycles and fluctuations affect the situation.
Risk Mitigation Techniques Applied:
The analysis uses a discounted rate of WACC – 2.2% to represent lower risk stemming from
the fixed sales agreement.
The accounting analysis included land value expenditure ($8.9M) to represent the lost
revenue from alternative business ventures.
Recommended Additional Techniques:
Sensitivity analysis on cost inflation, production volume, and discount rate.
The retailer discontinuing business operations after 5 years would require analysis in this
scenario. Are forecasted costs affected by an additional yearly growth of 1%?
The simulation develops various scenarios that show variable cost and growth parameters.
3. Limitations and Uncertainty in Part C (Asset Replacement Project)
Key Uncertainties:
Managerial projections about efficiency improvements and output growth are prone to fail
particularly in the early time period.
The projected savings during the first three months are reduced because learning curve delays
affect normal cost-saving efficiency.
The analysis lacked any specific calculations regarding productivity reduction together with
instrument downtime or implementation disturbances.
The estimated future worth of new equipment at $800,000 in year 10 has potential
inaccuracies in its estimation.
Risk Mitigation Techniques Applied:
The financial model incorporated limited cost savings during the first years of operation.
The analysis incorporates alterations in working capital elements between inventory and
receivables and payables for complete financial assessment.
The evaluation accounted for depreciation effects together with tax-related benefits.
Recommended Additional Techniques:
The analysis involves determining the minimum product output level and necessary cost
reduction amount needed for the project to become economical.
An analysis of sensitivity based on savings by unit and product volume and the market value
of grain whisky.
Scenario testing: Assess high-efficiency, moderate, and low-efficiency operating
assumptions.
General Limitations Across All Parts
An organization that uses a single-point WACC may fail to address different risk profiles
between individual projects
When inflation remains steady the market uncertainties can increase unpredictability rates.
Another limitation arises from the assumption of flat 30% taxes because upcoming legislative
changes can modify the tax rate.
Conclusion and Final Reflection
The findings and suggestions in Parts A–C rely on conventional industrial practices and
suitable modifications to discount rates. The investment outcomes could be impacted by
multiple assumptions concerning cost stability combined with project execution quality and
future conditions stability.
Management needs to integrate three recommended techniques including sensitivity analysis
and scenario testing and simulations as part of their review process to validate financial
decisions under market and operational uncertainties.
The capital investment process requires judgment alongside risk understanding and especially
applies to the long-term and specialized projects Golden Barrel Distillery has proposed.