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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 $27.00 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 $1.22 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.89 million per year and cost $2.09 million per year over the 10-year life of the project. Marketing estimates 19.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 34.00%. The WACC is 14.00%. Find the NPV (net present value).

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Expert Solution

Profit = (revenues-variable cost)*(1-switch %)
=(8890000-2090000)*(1-0.19)
=5508000
Time line 0 1 2 3 4 5 6 7 8 9 10
Cost of new machine -27000000
Initial working capital -1220000
=Initial Investment outlay -28220000
100.00%
Profits 5508000 5508000 5508000 5508000 5508000 5508000 5508000 5508000 5508000 5508000
-Depreciation (Cost of equipment-salvage value)/no. of years -2600000 -2600000 -2600000 -2600000 -2600000 -2600000 -2600000 -2600000 -2600000 -2600000 1000000 =Salvage Value
=Pretax cash flows 2908000 2908000 2908000 2908000 2908000 2908000 2908000 2908000 2908000 2908000
-taxes =(Pretax cash flows)*(1-tax) 1919280 1919280 1919280 1919280 1919280 1919280 1919280 1919280 1919280 1919280
+Depreciation 2600000 2600000 2600000 2600000 2600000 2600000 2600000 2600000 2600000 2600000
=after tax operating cash flow 4519280 4519280 4519280 4519280 4519280 4519280 4519280 4519280 4519280 4519280
reversal of working capital 1220000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 660000
+Tax shield on salvage book value =Salvage value * tax rate 340000
=Terminal year after tax cash flows 2220000
Total Cash flow for the period -28220000 4519280 4519280 4519280 4519280 4519280 4519280 4519280 4519280 4519280 6739280
Discount factor= (1+discount rate)^corresponding period 1 1.14 1.2996 1.481544 1.68896016 1.9254146 2.1949726 2.502268791 2.8525864 3.251948521 3.707221
Discounted CF= Cashflow/discount factor -28220000 3964280.702 3477439.212 3050385.274 2675776.556 2347172.4 2058923.2 1806072.959 1584274.5 1389714.496 1817879
NPV= Sum of discounted CF= -4048081.62

jeff jeffy answered 5 months ago
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