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Caspian Sea Drinks is considering the production of a diet drink. The expansion of the plant...

Caspian Sea Drinks is considering the production of a diet drink. The expansion of the plant and the purchase of the equipment necessary to produce the diet drink will cost $25.00 million. The plant and equipment will be depreciated over 10 years to a book value of $2.00 million, and sold for that amount in year 10. Net working capital will increase by $1.27 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.61 million per year and cost $1.50 million per year over the 10-year life of the project. Marketing estimates 16.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 27.00%. The WACC is 13.00%. Find the IRR (internal rate of return).

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Solutions

Expert Solution

Profit = (revenues-sales)*(1-switch%)
=(8610000-1500000)*(1-0.16)
5972400
Time line 0 1 2 3 4 5 6 7 8 9 10
Cost of new machine -25000000
Initial working capital -1270000
=Initial Investment outlay -26270000
Profits 5972400 5972400 5972400 5972400 5972400 5972400 5972400 5972400 5972400 5972400
-Depreciation (Cost of equipment-salvage value)/no. of years -2300000 -2300000 -2300000 -2300000 -2300000 -2300000 -2300000 -2300000 -2300000 -2300000
=Pretax cash flows 3672400 3672400 3672400 3672400 3672400 3672400 3672400 3672400 3672400 3672400
-taxes =(Pretax cash flows)*(1-tax) 2680852 2680852 2680852 2680852 2680852 2680852 2680852 2680852 2680852 2680852
+Depreciation 2300000 2300000 2300000 2300000 2300000 2300000 2300000 2300000 2300000 2300000
=after tax operating cash flow 4980852 4980852 4980852 4980852 4980852 4980852 4980852 4980852 4980852 4980852
reversal of working capital 1270000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 1460000
+Tax shield on salvage book value =Salvage value * tax rate 540000
=Terminal year after tax cash flows 3270000
Total Cash flow for the period -26270000 4980852 4980852 4980852 4980852 4980852 4980852 4980852 4980852 4980852 8250852
Discount factor= (1+discount rate)^corresponding period 1 1.14552974 1.312238386 1.503208097 1.7219696 1.9725674 2.2596346 2.588478616 2.9651792 3.396701 3.891022
Discounted CF= Cashflow/discount factor -26270000 4348077.423 3795691.435 3313481.354 2892531.9 2525060.5 2204273.2 1924239.192 1679781.1 1466379 2120485
NPV= Sum of discounted CF= 0.00
IRR is discount rate at which NPV = 0 = 15.0000%

jeff jeffy answered 7 months ago
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