Question

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 $23.00 million. The plant and equipment will be depreciated over 10 years to a book value of $3.00 million, and sold for that amount in year 10. Net working capital will increase by $1.20 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $9.26 million per year and cost $2.08 million per year over the 10-year life of the project. Marketing estimates 17.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 35.00%. The WACC is 10.00%. Find the NPV (net present value).

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#3

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 $26.00 million. The plant and equipment will be depreciated over 10 years to a book value of $1.00 million, and sold for that amount in year 10. Net working capital will increase by $1.48 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.53 million per year and cost $2.43 million per year over the 10-year life of the project. Marketing estimates 11.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 29.00%. The WACC is 14.00%. Find the IRR (internal rate of return).

Answer 1

Profit = (revenues-sales)*(1-switch%)

=(9260000-2080000)*(1-0.17)

5959400

Time line		0	1	2	3	4	5	6	7	8	9	10
Cost of new machine		-23000000
Initial working capital		-1200000
=Initial Investment outlay		-24200000
													100.00%
Profits			5959400	5959400	5959400	5959400	5959400	5959400	5959400	5959400	5959400	5959400
-Depreciation	(Cost of equipment-salvage value)/no. of years		-2000000	-2000000	-2000000	-2000000	-2000000	-2000000	-2000000	-2000000	-2000000	-2000000	3000000	=Salvage Value
=Pretax cash flows			3959400	3959400	3959400	3959400	3959400	3959400	3959400	3959400	3959400	3959400
-taxes	=(Pretax cash flows)*(1-tax)		2573610	2573610	2573610	2573610	2573610	2573610	2573610	2573610	2573610	2573610
+Depreciation			2000000	2000000	2000000	2000000	2000000	2000000	2000000	2000000	2000000	2000000
=after tax operating cash flow			4573610	4573610	4573610	4573610	4573610	4573610	4573610	4573610	4573610	4573610
reversal of working capital												1200000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)											1950000
+Tax shield on salvage book value	=Salvage value * tax rate											1050000
=Terminal year after tax cash flows												4200000
Total Cash flow for the period		-24200000	4573610	4573610	4573610	4573610	4573610	4573610	4573610	4573610	4573610	8773610
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331	1.4641	1.61051	1.771561	1.9487171	2.1435888	2.357948	2.593742
Discounted CF=	Cashflow/discount factor	-24200000	4157827.273	3779842.975	3436220.887	3123837.2	2839852	2581683.6	2346985.101	2133622.8	1939657	3382606
NPV=	Sum of discounted CF=	5522135.38

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