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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 $26.00 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 $8.77 million per year and cost $2.11 million per year over the 10-year life of the project. Marketing estimates 20.00% 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 15.00%. Find the NPV (net present value).

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Expert Solution

Profit = (revenues-variable cost)*(1-switch %)
=(8770000-2110000)*(1-0.2)
=5328000
Time line 0 1 2 3 4 5 6 7 8 9 10
Cost of new machine -26000000
Initial working capital -1340000
=Initial Investment outlay -27340000
100.00%
Profits 5328000 5328000 5328000 5328000 5328000 5328000 5328000 5328000 5328000 5328000
-Depreciation (Cost of equipment-salvage value)/no. of years -2400000 -2400000 -2400000 -2400000 -2400000 -2400000 -2400000 -2400000 -2400000 -2400000 2000000 =Salvage Value
=Pretax cash flows 2928000 2928000 2928000 2928000 2928000 2928000 2928000 2928000 2928000 2928000
-taxes =(Pretax cash flows)*(1-tax) 2254560 2254560 2254560 2254560 2254560 2254560 2254560 2254560 2254560 2254560
+Depreciation 2400000 2400000 2400000 2400000 2400000 2400000 2400000 2400000 2400000 2400000
=after tax operating cash flow 4654560 4654560 4654560 4654560 4654560 4654560 4654560 4654560 4654560 4654560
reversal of working capital 1340000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 1540000
+Tax shield on salvage book value =Salvage value * tax rate 460000
=Terminal year after tax cash flows 3340000
Total Cash flow for the period -27340000 4654560 4654560 4654560 4654560 4654560 4654560 4654560 4654560 4654560 7994560
Discount factor= (1+discount rate)^corresponding period 1 1.15 1.3225 1.520875 1.74900625 2.0113572 2.3130608 2.66001988 3.0590229 3.517876292 4.045558
Discounted CF= Cashflow/discount factor -27340000 4047443.478 3519516.068 3060448.755 2661259.787 2314138.9 2012294.7 1749821.509 1521583.9 1323116.453 1976133
NPV= Sum of discounted CF= -3154243.39

jeff jeffy answered 5 months ago
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