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 $24.00 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 $1.34 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.73 million per year and cost $1.62 million per year over the 10-year life of the project. Marketing estimates 18.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 30.00%. The WACC is 14.00%. Find the NPV (net present value).

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 $27.00 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 $1.06 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $9.09 million per year and cost $2.21 million per year over the 10-year life of the project. Marketing estimates 15.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 26.00%. The WACC is 14.00%. Find the IRR (internal rate of return).

Thanks!

Answer 1

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

=(8730000-1620000)*(1-0.18)

=5830200

Time line		0	1	2	3	4	5	6	7	8	9	10
Cost of new machine		-24000000
Initial working capital		-1340000
=Initial Investment outlay		-25340000
													100.00%
Profits			5830200	5830200	5830200	5830200	5830200	5830200	5830200	5830200	5830200	5830200
-Depreciation	(Cost of equipment-salvage value)/no. of years		-2200000	-2200000	-2200000	-2200000	-2200000	-2200000	-2200000	-2200000	-2200000	-2200000	2000000	=Salvage Value
=Pretax cash flows			3630200	3630200	3630200	3630200	3630200	3630200	3630200	3630200	3630200	3630200
-taxes	=(Pretax cash flows)*(1-tax)		2541140	2541140	2541140	2541140	2541140	2541140	2541140	2541140	2541140	2541140
+Depreciation			2200000	2200000	2200000	2200000	2200000	2200000	2200000	2200000	2200000	2200000
=after tax operating cash flow			4741140	4741140	4741140	4741140	4741140	4741140	4741140	4741140	4741140	4741140
reversal of working capital												1340000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)											1400000
+Tax shield on salvage book value	=Salvage value * tax rate											600000
=Terminal year after tax cash flows												3340000
Total Cash flow for the period		-25340000	4741140	4741140	4741140	4741140	4741140	4741140	4741140	4741140	4741140	8081140
Discount factor=	(1+discount rate)^corresponding period	1	1.14	1.2996	1.481544	1.6889602	1.9254146	2.1949726	2.502268791	2.8525864	3.251949	3.707221
Discounted CF=	Cashflow/discount factor	-25340000	4158894.737	3648153.278	3200134.454	2807135.5	2462399.5	2159999.6	1894736.495	1662049.6	1457938	2179837
NPV=	Sum of discounted CF=	291278.86

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