Calaveras Vineyards Harvard Case Solution & Analysis

Ratio Analysis Overview

Debt ratio

Debt ratio indicates that Calaveras Vineyards is a high geared and levered company. It is very risky for Goldengate Capital to invest in Calaveras Vineyards because the Standard Debt ratio is 0.4: 1. Whereas in 1st three years, debt ratio is exceeded by the benchmark rate, if in case, the company liquidated before 1997, so Goldengate Capital would have to suffer huge losses. However after 1997, the ratio will normalize and average debt ratio of market was 48%

Debt to equity ratio

Debt to equity ratio shows that Calaveras Vineyards will finance their fixed assets and long-term assets by more than 50% in 1994, 1995 and 1996 by using debt financing. This is very risky because debt to equity ratio should not exceed 0.4:0.6.  In 1997 and 1998, 44% and 31% portion of Calaveras Vineyards’ capital employed consists of debts. Debt to equity ratio suggests that it is more viable for Goldengate Capital not to invest in Calaveras Vineyards. The market comparison information shows that average rate is 35%.

Return on equity

Return on equity ratios tells that there is no issue of profitability to Calaveras Vineyard. This ratio is more than average return of vineyard market. If required return of Goldengate Capital is equal to average 20%-25% so company should invest in Calaveras Vineyards as per estimation of return on equity ratio.

Gross profit margin indicates that Calaveras Vineyards contributes approximately more than 40% to set-off operating expenses. The average gross profit rate is 40% of Brand and Wine industry. Under this analysis, Goldengate Capital will have a better option to invest in Calaveras Vineyards.

Net income rate

Calaveras Vineyards earns net income 11% to 14% of total sales, which is much better in comparison with the average net income rate of market that is 2%. Net income rate shows that this can be a good option for Goldengate Capital to invest and get return of 11% to 14%.

Operating income rate

Calaveras Vineyards produce 25% to 26% operating income on its investment, which is considered as a good return in brandy and wine industry. It is recommended to Goldengate Capital to avail the opportunity if they do not have the opportunity to earn more than 26% of operating income.

Enterprise Valuation

Valuation of Calaveras Vineyards is done under discounted cash flows method.

Discounted cash flows

Discounted cash flows method suggests that the fair value and target price of Calaveras Vineyards today, based on the projections of future company’s cash flows, which is $13,618,860. The value of Calaveras Vineyards is much more than the average market value of comparative.

While calculating the value of company under discounted cash flows methods

  • Cash flows will grow 2% in perpetuity
  • Cost of capital is 10% for simplicity of calculation

Weighted average cost of capital (WACC)

The Calaveras Vineyards ‘cost of capital is 10.8%, which indicates that the minimum return that accompany is estimated to pay its creditors, common equity holders and other provider of capital. If the required rate of Goldengate Capital is lower and equal to the WACC of Calaveras Vineyards, so it is recommended to invest in Calaveras Vineyards.

Financial statement

Forecasted balance sheet of Calaveras Vineyards provides the following important key factors:

  1. Current ratio- The current ratio of a company is 1.24 to 2.16, which is acceptable. The average current ratio of industry is 2.
  2. Quick ratio- Company’s quick ratio is between 0.2 and 0.33, whereas market average ratio is 0.44 which is quite nearer.
  3. Total assets- Company’s total assets are estimated to be $4 million to $5 million, which is much higher than the average assets of industry. Whereas, the market average assets cost $1.2 million.
  4. Retained earnings- Equity section of financial statement  shows that retained earnings is increasing to be $2.9 million and the share capital of amount $1 million remains constant during the period.
  5. Long-term debts- At the end of the third year, Calaveras Vineyards’ loan will get fully paid. As a result, company’s gearing percentage as well as their debt ratio and financial gearing ratio will also improve. There will be no liquidity issue faced by the company in long-term.

Projected income statement shows the following important facts

Calaveras Vineyards Case Solution

  1. Sales revenue- sales revenue will increase from $3 million to $5 million within four years.
  2. Gross profit- gross profit will reach to $2.2 million in 1998.
  3. Net income- the income attributable to shareholder and income transfer to reserve account will increase $0.3 million to $0.7.

(Exhibit 10) However, solvency ratios analysis shows that interest rates in the proposal are at end limit of expectations...................................

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