Archer Wineries is a leading New South Wales wine producer. Archer's management is currently evaluating a potential new product; a light, fruity wine designedtoappealtotheyounger generation.Thenewproduct,WineGold,wouldbepositionedbetweenthevariouswinecoolersandthetraditionalwines.Thenewproductwouldcostmore thanwinecoolers, but less than premium table wine, and in market research samplings at the company'sheadquarters, it was judged superior to various competing products. Jan Armstrong, the ChiefFinancialOfficer,mustanalysethisproject,alongwithotherpotentialinvestments,andthenpresenther findings to thecompany's executivecommittee.

Production facilities for the new wine product would be set up in an unused section of Archer'smain plant. Relatively inexpensive, used machinery with an estimated cost of only $500,000 wouldbe purchased, but shipping costs to move the machinery to Archer's plant would total $40,000, andinstallation charges would add another $60,000 to the total equipment cost. Further, Archer'sinventories(the newproduct requiressomeaging atthewinery) would havetobe increasedby

$20,000, and this cash flow is assumed to occur at the time of the initial investment. The machineryhas a remaining economic life of 4 years and the Inland Revenue ruling will allow Archer Wineriestoclaim the followingannual depreciation allowances:

Year1:	33%	Year2:	45%
Year3:	15%	Year4:	7%

Themachineryisexpected tohaveasalvagevalueof$50,000after 4yearsofuse.

The section of the plant in which production would occur has not been used for several years, andconsequently had suffered some deterioration. Last year, as part of a routine facilities improvementprogram, Archer spent $200,000 to rehabilitate that section of the main plant. Ian Smith, the chiefaccountant, believes that this outlay, which has already been paid and expensed for tax purposes,should be charged to the wine project. His contention is that if the rehabilitation had not takenplace,the firm wouldhavehad to spendthe$200,000 tomakethe sitesuitableforthe wineproject.

Archer's management expects to sell 200,000 bottles of the new wine product in each of the next 4years, at a wholesale price of $4 per bottle, but $3 per bottle would be needed to cover fixed andvariable cash operating costs. In examining the sales figures, Armstrong noted a short memo fromArcher's sales manager which expressed concern that the wine project would cut into the firm'ssales of wine coolers - this type of effect is called an externality(or opportunity cost).Specifically,the sales manager estimated that wine cooler sales would fall by 5 percent if the new wine wereintroduced. Armstrong then talked to both the sales and production managers, and she concludedthat the new project would probably lower the firm's wine cooler sales by $40,000 per year, but, atthe same time, it would also reduce production costs for this product by $20,000 per year, all on apre-tax basis. Thus, the net externality effect would be -$40,000 + $20,000 = -$20,000. Archer'seffectivetaxrate is40 percent, and itsoverall costof capitalis 10 percent.

DepreciationSchedule		Table1
Year	Depn.Allowance	Depn.Expense	End-of-YearBookValue
1	33%	$198,000	$402,000
2	X	X	X
3	X	X	X
4	7%	$600,000	$ 0
	100%

Cash Flow Statement					Table 2
	Year 0	Year 1	Year 2	Year 3	Year 4
Unit price
Unit sales
Net Investment Outlay
Price
Freight
Installation
Change in NWC
Operating cash flows
Revenues
Operating Costs
Depreciation
Other project effects
Before-tax income
Tax
Net income
Plus depreciation
Net operating cash flow
Salvage value
Salvage value tax
Recovery of NWC
Project net cash flow
Note: The WACC (Weighted Average Cost of Capital) of 10% is the appropriate discount rate to use when evaluating this project

Question1

CompleteTables1and2anddeterminethe cashflowsforthe projects.

Question2

Usingtherelevantcashflowsidentifiedin Tables 1and2, calculatetheprojects:

1. NetPresentValue(NPV)
2. InternalRateofReturn(IRR)
3. PaybackPeriod
4. Willyourecommend thattheprojectshould beundertaken?Whyorwhynot?