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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 $24.00 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 $1.26 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $9.02 million per year and cost $1.54 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 23.00%. The WACC is 13.00%. Find the IRR (internal rate of return)

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Expert Solution

Profit = (revenues-variable cost)*(1-switch %)
=(9020000-1540000)*(1-0.18)
=6133600
Time line 0 1 2 3 4 5 6 7 8 9 10
Cost of new machine -24000000
Initial working capital -1540000
=Initial Investment outlay -25540000
Profits 6133600 6133600 6133600 6133600 6133600 6133600 6133600 6133600 6133600 6133600
-Depreciation (Cost of equipment-salvage value)/no. of years -2300000 -2300000 -2300000 -2300000 -2300000 -2300000 -2300000 -2300000 -2300000 -2300000
=Pretax cash flows 3833600 3833600 3833600 3833600 3833600 3833600 3833600 3833600 3833600 3833600
-taxes =(Pretax cash flows)*(1-tax) 2951872 2951872 2951872 2951872 2951872 2951872 2951872 2951872 2951872 2951872
+Depreciation 2300000 2300000 2300000 2300000 2300000 2300000 2300000 2300000 2300000 2300000
=after tax operating cash flow 5251872 5251872 5251872 5251872 5251872 5251872 5251872 5251872 5251872 5251872
reversal of working capital 1540000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 770000
+Tax shield on salvage book value =Salvage value * tax rate 230000
=Terminal year after tax cash flows 2540000
Total Cash flow for the period -25540000 5251872 5251872 5251872 5251872 5251872 5251872 5251872 5251872 5251872 7791872
Discount factor= (1+discount rate)^corresponding period 1 1.16427141 1.355527916 1.578202397 1.83745593 2.1392974 2.4907228 2.899877353 3.3762443 3.930864703 4.576593
Discounted CF= Cashflow/discount factor -25540000 4510865.728 3874410.803 3327755.686 2858230.184 2454951.8 2108573.5 1811066.939 1555536.7 1336060.23 1702548
NPV= Sum of discounted CF= 0.00
IRR is discount rate at which NPV = 0 = 16.43%

jeff jeffy answered 5 months ago
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