Contents

Page

Question One

Question Two

Calaveras Vineyards Report

Contents

1. Executive Summary

2. Background

3. Qualitative Analysis

4. Quantitative Analysis

5. Appendices

6. Conclusions and Recommendations

3

3

4

5

6

7

9

13

17

20

Question One

1.1 E

1.2 C

1.3 D

1.4 D

1.5 E

1.6 B

1.7 B

1.8 B

1.9 D

1.10 A

1.11 D

1.12 C

1.13 C

1.14 E

1.15 D

1.16 C

1.17 A

1.18 A

1.19 B

1.20 C

Question Two

Calaveras Vineyards Report (below)

Calaveras Vineyards

Report

Contents

Page

1. 1. Executive Summary

2. 2. Background

3. 3. Qualitative Analysis

4. 4. Quantitative Analysis

5. 5. Appendices

6. 6. Conclusions and Recommendations

6

7

9

13

17

20

1 Executive Summary

This report investigates whether NationsBank should approve the loan application of

$4.5 million to purchase Calaveras Vineyards. The method of investigation entailed

reviewing the historical data provided. A Discounted Cash Flow (DCF) was

formulated, NPV and Payback was also calculated.

The three main factors considered in the estimates were case sales trends and

demand, inflation and real price increases reflect Calaveras strengthening their

brand recognition. The first assumption is that the prices will increase 2% before

inflation. The production per ton of grapes and yield per acre increased in 1992 due

to the new market strategies. Sales are expected to grow 13% in 1995 after which an

estimate of 12%, 6%, and 8% for 1996, 1997 and 1998 respectively, show growth

while recognising a shift toward white wines – translating into an annual projection of

10% per for the forecast period – Appendix 5. The tax rate of 37% and inflation rate

of 2% is taken into account in the forecast. Therefore the prices per case for each

category has 2% price growth as well as 2% inflation rate, the total of 4% is reflected

in the forecasted income statement. The key drivers of this model are Gross margin

on each of the 5 main product groups, tax rate, inflation rate, real-price growth level,

interest rate, Accounts Receivable to Sales ratio.

NPV and Payback was favourable as a positive NPV indicates that the investment is

a good one. Payback was calculated to be 1.07 years and this means that the bank

would easily make their money back. The IRR was approximately 93%. This deal

should be approved.

The final recommendation supports the application. Also contained in the final

recommendations, the reader will be able to observe a wider, marketing – customer

centric approach to business practice and marketing efforts to control costs and

encourage business growth.

2 Background

An internal assessment of Calaveras Vineyards indicates a relatively stable going

concern, which is stable in the alcoholic beverage industry as a wine producer and

supplier. The company was originally started by Estaban Calaveras in 1883 and has

since expanded its supply market from the focus church wine consumption to

retailing, wholesaling and specialised customer supplies (Gigantic Airlines). It offers

a full range of wines by product range and price positioning, including Chardonnay,

Sauvignon Blanc and Cabernet Sauvignon, and some lesser quality products which

provide reach.

The recent management buyout proposal, considered in this document, indicates

the confidence of the management team, who know and understand the market

particular to both the company and its specific trading activities. The buyout team

consists of Dr Lynn Martinez, who has been working in the company since 1987 and

aims to own 85% of the business. Newsome, the current operations manager will

buy the remaining 15%. Martinez and Newsome intend to recruit the marketing

service to Winston-Fendall (who has recently lost their flag-ship account) as their

marketer. Besides being a strong marketer, Winston-Fendall will also offer collection

service for payables, offering to pay a receivable unpaid after 90 days – providing a

strong mechanism to secure Calaveras cash-flow position, Calaveras Vineyards

operates off 220 acres of land, sourcing the majority of its grapes off 175 acres of

this land. The remaining land is used for operational plants and processing functions

of the business, as well as a winery for public visits, where they also sell products

direct to the public at maximum margins. Additional incomes stem from direct supply

accounts they serve, representing yet again greater margin as compared to their

wholesale channels. Gigantic Airlines have guaranteed their demand at a minimum

of 16500 cases for the next periods, while the hotel channel has grown considerably

over the past three years to 2090 cases, expected to stabilise at 4000 cases for the

next five years. Essentially, sales are projected to grow at an average of 10%

annually over the next 5 years.

The external forces affecting this market, and therefore ultimately Calaveras

Vineyards is affected by its competitors from local and international brands. The

American population is said to have taken kindly to the general opinion that drinking

red wine is good for people’s health. This market is therefore expected to grow at a

higher rate than the expected permissible price increases with-in this market. Market

share is therefore imperative, as profits will be affected by a reduction in share

because prices do not cater adequately for inflationary increases that they would be

subjected to. Wine sales are expected to maintain its volume growth of 7.4% v/s

other spirits averaging at 2.2% annually.

3 Qualitative analysis

Calaveras Vineyards is a much smaller entity as compared to its competitors, who

celebrate much higher revenues while having brands which are comparable with

Calaveras Vineyards products, yet trade more volumes than Calaveras Vineyards

does. It is understood though, that with such competition, that Calaveras Vineyards

would have to expand its share by volumes by ensuring market positioning in the

hearts of consumers. Building brands and demand will challenge their current supply

chain of grapes; the company already sources approximately 50% of their raw

products from long-term contracts. These contracts are fixed-term and would require

urgent security to ensure supplies. A previous shortage, due to crop infestation

taught the lessons of how significantly carefully the team would need to manage their

risk mitigation.

A further consideration of the external market factors recognises that wine sales at

supermarkets have shown a significant increase as compared to beer. This presents

an opportunity for Calaveras Vineyards, while it will also strain relationships if the

expansion excluded Winston-Fendall. Though internal by contract, we urge

consideration of the exposure to wholesale commitments because of 50 percent of

their total volume is handled by 2 of their 9 distributors. Calaveras Vineyards is

therefore to be considered as either exposed or reliant on dedicated partners. This

security requires evaluation, yet at this stage appears stable.

Expansion scope in the retail stores is consider highly competitive, and strongly

brand centric. Though the Calaveras Vineyards brand positioning is stable and

secure, owing to the range of products which have been carefully crafted, with peer

pressure on market share playing a vital role in expanding the Calaveras Vineyards

share. This raw material demand therefore remains increasingly strained if

Calaveras Vineyards should succeed in increased supply to demand, but more

importantly, to increasing sales relative to maintaining strategic advantages in the

niche’ (by volumes) business.

Strengths

1. Small company – able to be

dynamic and flexible.

2. Strong brand position.

3. Stable high volume customer

base.

4. Experienced owners, who relate

passionately to their company.

5. Entrepreneurial intentions of new

owners.

Weaknesses

1. Size and security may limit reach

and sales volumes – thereby

revenues.

2. Supply agreements with future

competitive suppliers to supply

grapes.

Opportunities

1. Increase high margin sales

channels without reducing other

volumes.

2. Brand position stable: marketing

activities required to build demand

and testing of new sales markets.

3. International sales will provide the

greatest range of expansion

potential.

4. Cash-flow security in receivables

collection by marketing company.

5. Loan facility will support inventory

volumes, to increase stock holding

and supply rates, top major

accounts who buy greater

volumes.

6. Expansion along airlines routes.

Threats

1. Cash flow limitations may come

into the spot-light as the company

pursues the proposed 2.5 million

dollar revolving loan, to fund

inventory and other expenses.

2. Supply of grapes for making

wines.

Table 1: SWOT Analysis

Exploiting Strategic Opportunities and mitigating Threats

The loans applied for by the future owners’ demands focussing on improved cash

flows in the business. This threat governs their future ability to pay debt while also

highlights the need for them to increase brand positioning in a growing market

segment – wines. This area of the business will demand greater amounts of

contractual securities and possible management controls over the supply network –

potentially introducing leasing options of the land to ensure securities.

This approach will serve well to defend against sales volumes growth being limited

by the supply chain and ultimately may become a source of expertise development

into improved farming methods to increase yield and quality. The options of leasing

may even work well if employees are better incentivised to work toward achieving

these standards and objectives.

Appraisal of functional competencies of strengths and weaknesses

Being a relatively smaller entity in the market can be a position of strength, offering

the flexibility and specialisation alternatives giants may be slower to move on. As

these will be owner run businesses, they are more likely to be more entrepreneurial

and dynamic in handling marketing efforts on a one-on-one basis with potential

buyers in retail stores and hotels. The niche profile they may retain (a volume-based

argument) could allow them personalisation opportunities which larger entities may

be slower to move on.

Personalisation of particular products may be limited, while Calaveras Vineyards

also needs to ensure that such actions do not dilute the brand. The stable high

volume customer base will ensure future sales volumes and direct marketing

methods can be tailored made to meet these sectors head-on to increase volumes. It

may be an ideal breeding ground for promoting the health benefits of wines in adults

while promoting a youthful adult lifestyle which is supported by natures own anti-

toxins to stresses and the challenge of aging and chronic health risks.

Brand position will therefore need to be moved up a scale, to ensure long-term retail

price levels at higher margins and volumes. Calaveras Vineyards future owners are

experienced players who know there business. They are bound to have the

networking savvy which will be capitalised on in future branding and market

expansion efforts. International marketing efforts may also be able to capitalise on

the Californian wines acceptance levels in global markets. Recognising the scale of

supply, makes it prudent that such activities should focus yet again on niche

positioning at upscale hotels which serve their current airline destinations and

partners.

4 Quantitative Analysis

Quantitative analyses focuses on the formulation of financial information in an effort

to evaluate the business and pending deal in view of the previous financial data, to

determine its applicability, evaluate proposed growth aspects in relation to forecasts

and projections as compared to trends and norms of the industry. The objective is to

make sense of these facts from the perspective of the risk to the funders and to

determine whether the new owners would be able to meet the obligations of this

loan. This section looks first at current information to determine the going concerns

liquidity, then forecasts in relation to benchmarked capacities.

The weight of products and the comparable companies’ unlevelled beta was used to

calculate the cost of capital. With these assumptions, WACC was calculated to be

16.17%. Free cash flows (FCF) were determined while discounting FCF at a WACC

(16.17%), the value of Calaveras Vineyards was calculated to be $3 647 000.

Risk mitigation considering bankruptcy:

Bankruptcy in business, due to changes in markets or ineffective marketing methods,

is any entrepreneur or investors reality. Even destroyed crops are a reality in this

business. Therefore assessing this undesired ultimate exit is prudent. In this stage of

the analysis, we consider valuing the operation to determine the fair-market value of

Calaveras Vineyards and to mitigate risk in a case of forced liquidation.

There are two types of liquidation values, depending on the time available for the

liquidation process, Orderly liquidation value and Distress liquidation value.

Orderly liquidation value - assumes that the enterprise can afford to sell its assets to

the highest bidder. It assumes an orderly sale process to sell each asset in its

appropriate season and through channels of sale and distribution that fetch the

highest price reasonably available – (Orderly liquidation value = Net working capital

+ fixed assets – long-term debt).

  Ratios   Meaning

Comparison to Industry norm

Solvency

Quick ratio (x) CA-Inventory / CL Firms ability to pay CL without relying on the sale of it inventories

  190 649.00

 

  0.51

Falls into the category higher than the median but lower than the Upper Quartile

     

Current ratio (x) CA / CL Firms’ ability to pay CL using assets that can be converted into cash in the near term.

  2.00

Fall into the category higher than the lower quartile but lower than the median

     

CL to net worth (%)

29.20

Lower than the median but higher than the upper quartile

 

Efficiency

Collection period (days)

Accounts receivable / (Total sales / 365)

Length of time to receive money from debtors after the sale is done

  99189/(752554/365)

Lower is better. Higher than upper quartile but lower than median

  48.11 days       Sales to inventory (x)

1.34

Lower than median but higher than lower quartile

     

Asset to Sales (%) 171.17

Between lower quartile and median

     Acc payable to Sales (%)

12.67

Higher than median but lower than lower quartile

Table 2: Liquidity Ratios: 1993 evaluates going concern as an investment

As observed in table 2 above, the liquidity of the going concern is on par or better

than norms. Indicating financial confidence is justified. It does matter to consider the

impact of the proposed funding plan to determine the liquidity of the future operation.

Appendix 2 - NPV: The Net Present value analysis indicates positive results which

support the qualitative assessment into the viability of this venture and safety

margins to the funders. This result is pleasing and assertive.

Distress liquidation value - this is an emergency price. This assumes that the

company must sell all its assets at or near the same time, to offer the assets is a

dealer who specialises in the liquidation of the entire assets of a company

We know Calaveras can sell Accounts Receivable at 85% of the face value and

Inventory 75% of book value and Equipment 40% of book value in a forced

liquidation.

Table 2: Reduction in future collections periods require: administrative and fiscal

discipline to ensure cash flow benefits and loan servicing.

Using the discounted cash flows, P/E ratios and the liquidation method, $3.66 million

is a good price. What is even more important is that cash flows generated by the

forecasted revenues supports fully paying off the term loan by paying off principal

payment of 60,000 per year for the next five years while at the end of the 5th year

revolving line credit could be reduced to 0.4 million and Debt Ratio was reduced from

75% in 1994 to 44% in 1998. This allows the Calaveras Vineyards to assume more

funding for expansion and/or reduce the interest expenses while increasing the

return on investment.

Est

ates

Sel

ect

Vin

eyar

ds

Cal

iforn

ia

Gen

eric

Spe

cial

Acc

ount

s

Win

ery

-

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

2,000,000

1994 1995 1996 1997 1998

Projected revenue from wine types per sales channel / annum

Figure 1: Projected revenue from wine types per sales channel / annum

Figure 1 above, highlights the dependence this business has on revenue fulfilment in

estates and “select vineyards” product-lines. The sourcing of grapes from selected

vineyards which stands out in relation to the sales and margin gains from this

product line. It implies a strong dependence on the acclaimed product and

encourages the new owners to re-visit the supply chain supporting these lines

continued success as a contributor to the bottom line and ultimate survival of the

business. Certainly, it therefore also remains comforting that continued security and

market share will contribute tremendous value to long-term brand building among

enthusiasts of this brand from Calaveras Vineyards.

Needless to say, are the gains from “estate wines” and “special accounts”, which

have a certain future for volume creation and facility utilisation and deserves special

attention as their combined value surpasses the “select vineyards” range volumes.

5 Appendices

Appendix 1

Appendix 2

Appendix 3

6 Conclusions and recommendations

Observations of the revenue streams in the sales per channel does not reflect the

turn-over projected by the future owners, this is a concern and requires discussions.

Yet leading the discussion from the information provided, we strive to recommend

that the transaction has reached its ‘go’ point and deserve consideration.

The 110 000 maximum capacity may support the projections, yet in the nature of

such useful land, it could be considered that the lost space used for offices and other

winery function, may well be considered to be relocated to increase capacity. The

objective should be minimising other uses for this land – supports concept of investor

confidence.

Liquidity of the going concern is reassuring. The future ratios may not be as

impressive and may demand more prudence on the part of the funders, to increase

the returns and offset future risks in this profile. Security from Winston-Fendall is

reassuring when considering the new owners capacity to repay debt. This author

suggest that controlling the debt ratios may assert the relevant controls on the

owners management functions to improve collections and cash flows, reduce

expenses and capitalisation to avoid increased exposure and delays in repayments.

Fiscal discipline is called for.

As may not be common to the entrepreneurs spirit, the funder should curtail

overzealous marketing activities, thereby setting relevant, negotiated, limits on this

expenditure and drive home a greater willingness to use modern direct marketing

methods which consist of networking with existing suppliers and consumer groups

which may yield suitable sales volumes at lower costs – the effect of targeted

marketing.

As is also common, focussing still on expense management, it is encouraged yet

again that the new owners consider a customer centricity program to improve the

over-production process, image building culture and marketing theme which is more

cost effective and builds long-term sustainability and trust. The product range is

diverse, and this is acknowledged, yet customer centricity at all levels of the value

chain produce competitive advantages.

These recommendations are seen from a financial prudence perspective as well as

the business growth perspective, not commonly considered relevant to financial

analysis yet ultimately essential to ensuring success in business.