Since 1899, for more than a century, Sanpellegrino Group has been a well-established name throughout the world, synonymous with the highest quality. Distributed in over 120 countries in all five continents, all its products – from non-alcoholic aperitifs to soft drinks – represent quality excellence, especially its extraordinary mineral waters. By virtue of their origins, a strong relationship with Italy, its culture and its traditions, Acqua Panna and San Pellegrino perfectly interpret Italian style as a synthesis of conviviality, well-being and fine dining. Sommeliers, chefs and connoisseurs worldwide, from the Unites States to France, Germany to Canada, the UK to Australia, Japan to Emirates concur that these two premium waters are the quintessence of Italian lifestyle and good taste, thus gracing the world’s finest dining tables .
After seeing other competitors’ success with flavored sparkling water, SanPellegrino S.p.A. has decided to consider an expansion of its own product line in this business. The product line being considered is flavored sparkling water with “San Pellegrino Limonata” as the new brand name. Assume that you were recently hired as an assistant to the firm’s financial manager, and you must evaluate the penetration in this new product line.
This flavored sparkling water would be produced in an unused building adjacent to the company’s main Plant in Italy; SanPellegrino S.p.A. owns the building, which is fully depreciated; but it has a current fair market value of $1,200,000. To start this project, SanPellegrino S.p.A. has to incur several capital expenditures
as follows:
The latest sophisticated machinery, to produce flavored sparkling water, costs $540,000, plus an additional $60,000 to be incurred for shipment and installation costs. Moreover, this expansion project necessitates the acquisition of some new equipment for $500,000. Initially, working capital assets would rise by $250,000, while working capital liabilities would go up by $50,000. The change in net working capital is expected to be 10 percent the yearly sales thereafter. According to the local rules and regulations, the machinery is to be depreciated under the MACRS system as 3-year property. The applicable depreciation rates are 33 percent, 45 percent, 15 percent, and 7 percent. The building and equipment are to be depreciated according to the straight-line method with a useful life of 30 and 5 years respectively.
SanPellegrino S.p.A. is expected to renew its machine by new one, of the same type, at the beginning of the fourth year. The old machine will have a salvage value of $35,000 whereas the market value of the new one is $560,000 including all necessary costs to put this machine into use for the first time. This expansion project is expected to operate for 5 years, at which time it will be terminated. The cash inflows are assumed to begin one year after the project is undertaken (year one) and to continue out to year 5. At the end of the project’s life, it is anticipated to liquidate the machinery and equipment for a total of $500,000. The machinery is solely expected to sell at a fair market value of $320,000 at the end of year five. Due to the booming in the local real estate market, the building is anticipated to have a salvage value of $1,600,000
SanPellegrino S.p.A. expects to sell a total 1,800,000 bottles for the first year at an expected sales price of $1.50 per bottle. Unit Sales are expected to grow by 20 percent each in years 2 and 3, due to the increase in the brand’s market share, and to slow down to a 10 percent growth thereafter. The cost control department anticipates an increase of 10 percent per year in the sales price per bottle starting the beginning of year 3. Cash operating costs for the project are expected to total 50 percent of dollar sales throughout the life of the project. SanPellegrino S.p.A. is subject to a marginal tax rate of 40 percent applied to all corporate profits, an average tax rate of 32 percent applied to all corporate profits, and a tax rate of 10 percent to be applied to various capital gain/loss transactions.
Tentatively, the SanPellegrino Limonata project is assumed to have a different risk than SanPellegrino S.p.A. Based on the analysts’ judgments, the firm’s cost of capital is 8 percent whereas the project’s cost of capital is anticipated to be 15 percent.
You have been asked by the financial manager to evaluate the project and to make the proper recommendation as to whether it should be accepted or rejected
