It is November $2020.$ Kasim Nasser, an entrepreneur in the Silicon Valley, has just founded Palo Alto

Micro$-$Brewing Co$.($PAMBCo$),$ a very fancy high$-$quality micro$-$brewery in the Bay Area, California.

He is the sole owner and CEO of the company. PAMBCo is considering acquiring at the end of $2020$

a $$4$ million Brauhaus $1000$A$,$ a large microbrewery system.

This investment has an economic life of eight years. In the U$.$S$.,$ it falls into the $7-$year property class

for depreciation purposes under the modified accelerated cost recovery system $($MACRS$).$ As a

result, the schedule permits depreciation of $14\mathrm{.}29\%$ in the first year, $24\mathrm{.}49\%$ in the second year,

$17\mathrm{.}49\%$ in the third year, $12\mathrm{.}49\%$ in the fourth year, $8\mathrm{.}93\%$ in the fifth year, $8\mathrm{.}92\%$ in the sixth year,

$8\mathrm{.}93\%$ in the seventh year, and $4\mathrm{.}46\%$ in the eighth year.

PAMBCo plans to keep the new microbrewery system for five years, until the end of $2025.$ At this

point, Kasim believes he will be able to sell the system to another beer enthusiast for $$1$ million. He

plans to close down shop in $2026.$

A pre$-$market estimate shows that in $2021,$ PAMBCo will be able to sell $400,000$ bottles of beer at a

price of $$5/$bottle$.$ In $2021-2026,$ the demand for the company$$s product is expected to increase by

$50,000$ bottles annually. The cost of production is expected to remain constant at $$1/$bottle$.$ All sales

are attributable to PAMBCo$$s new microbrewery system.

PAMBCo$$s combined marketing and overhead cost in $2020$ is expected to be $$200,000.$ In $2021-$

$2025,$ this cost is expected to be $$375,000.$ In $2026,$ there will be no marketing and overhead cost.

PAMBCo$$s product will not go on sale until $2021,$ but in $2020$ the plan is to produce $100,000$ bottles

prior to the initial $2021$ launch. In $2021-2025,$ the plan is to keep end$-$of$-$year inventories equal to

$25\%$ of the next year$$s anticipated demand. In $2026,$ the plan is to simply sell the remaining

inventory, thus only satisfying $25\%$ of the annual demand.

To value investment in Brauhaus $1000$A$,$ Kasim must make several assumptions. First, he assumes

that all numbers are year$-$end figures. Second, he assumes that $2020$ payments are made at yearend $($and to make discounting easier he values the project on December $31,2020).$ Third, even

though the equipment is put into use in $2020$ to produce the initial inventory, Kasim assumes that

first depreciation expense is only taken in $2021.$ This is because there is too little of $2020$ left to

risk conflict with the U$.$S$.$ Internal Revenue Service. Fourth, he assumes that the project will entail

no accounts receivable and accounts payable. Finally, he assumes that PAMBCo can use the tax carry

This mini$-$case is written by Professor Alexander S$.$ Gorbenko for use in classroom discussion.

forward provision in the U$.$S$.$ tax code to decrease its tax in $2021,$ offsetting the firm$$s loss in $2020.$

As an aside, there is no tax carry back allowed in the U$.$S$.$ since $2018.$

PAMBCo$$s additional base$-$case assumptions: the corporate tax rate is $21\%$; the risk$-$free rate is $2\%$;publicly traded companies with risk similar to PAMBCo have a $12\%$ required return.

a$.$Do you agree or disagree with Kasim$$s assumptions about the discount rate?

Explain your answer.