Question

Caspian Sea Drinks is considering the purchase of a plum juicer – the PJX5. There is no planned increase in production. The PJX5 will reduce costs by squeezing more juice from each plum and doing so in a more efficient manner. Mr. Bensen gave Derek the following information. What is the IRR of the PJX5?

a. The PJX5 will cost $2.16 million fully installed and has a 10 year life. It will be depreciated to a book value of $203,406.00 and sold for that amount in year 10.

b. The Engineering Department spent $21,951.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $20,397.00.

d. The PJX5 will reduce operating costs by $388,503.00 per year.

e. CSD’s marginal tax rate is 22.00%.

f. CSD is 65.00% equity-financed.

g. CSD’s 10.00-year, semi-annual pay, 5.52% coupon bond sells for $1,018.00.

h. CSD’s stock currently has a market value of $20.09 and Mr. Bensen believes the market estimates that dividends will grow at 2.64% forever. Next year’s dividend is projected to be $1.53.

Answer 1

Formula	Year (n)	0	1	2	3	4	5	6	7	8	9	10
	(Numbers in $000's)
	Initial investment (I)	-2160
S	Savings in operating cost ('S)		388.5	388.5	388.5	388.5	388.5	388.5	388.5	388.5	388.5	388.5
(Price of juicer - selling price) = accumulated depreciation;	Depreciation (D)		-195.66	-195.66	-195.66	-195.66	-195.66	-195.66	-195.66	-195.66	-195.66	-195.66
Depreciation/year = accumulated dep./10-D
(S-D)	Operating profit (OP)		192.84	192.84	192.84	192.84	192.84	192.84	192.84	192.84	192.84	192.84
22%*OP	Tax @22%		-42.43	-42.43	-42.43	-42.43	-42.43	-42.43	-42.43	-42.43	-42.43	-42.43
(OP-Tax)	After-tax profit (P)		150.41	150.41	150.41	150.41	150.41	150.41	150.41	150.41	150.41	150.41
	Add: depreciation (D)		195.66	195.66	195.66	195.66	195.66	195.66	195.66	195.66	195.66	195.66
(P+D)	OCF		346.07	346.07	346.07	346.07	346.07	346.07	346.07	346.07	346.07	346.07
Since it is sold at Book Value, no tax will be paid.	After-tax salvage value (SV)											203.41
(II+OCF+SV)	FCF	-2160	346.07	346.07	346.07	346.07	346.07	346.07	346.07	346.07	346.07	549.48
	IRR	10.46%
IRR = 10.46% (calculated using IRR function in excel)
Note: Research cost and plant floor renovation cost will not be included in the FCF since they are sunk costs.