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 NPV of the PJX5?

a. The PJX5 will cost $1.53 million fully installed and has a 10 year life. It will be depreciated to a book value of $205,829.00 and sold for that amount in year 10.

b. The Engineering Department spent $12,750.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $20,878.00.

d. The PJX5 will reduce operating costs by $484,561.00 per year.

e. CSD’s marginal tax rate is 24.00%.

f. CSD is 75.00% equity-financed.

g. CSD’s 12.00-year, semi-annual pay, 5.67% coupon bond sells for $951.00.

h. CSD’s stock currently has a market value of $20.65 and Mr. Bensen believes the market estimates that dividends will grow at 3.48% forever. Next year’s dividend is projected to be $1.61."

Please round to 2 decimal places

Answer 1

WACC calculation:

Cost of equity (ke) = (D1/P0) + g = (1.61/20.65) + 3.48% = 11.28%

Cost of debt (kd): PV = -951; FV = 1,000; PMT = coupon rate*FV/2 = 5.67%*1.000/2 = 28.35; N = 12*2 = 24, solve for RATE.

Semi-annual YTM = 3.13%, so kd = 2*3.13% = 6.26%

WACC = (we*ke) + (wd*kd*(1-Tax rate)) = (75%*11.28%) + (25%*6.26%*(1-24%)) = 9.65%

NPV = 1,047,872.10

Research and floor modification costs are not included in the NPV calculation as they are sunk costs.