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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 $1.00 million, and sold for that amount in year 10. Net working capital will increase by $1.04 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.90 million per year and cost $2.32 million per year over the 10-year life of the project. Marketing estimates 14.00% 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 14.00%. Find the NPV (net present value).

Solutions

Expert Solution

Profit = (revenues-variable cost)*(1-switch %)
=(8900000-2320000)*(1-0.14)
5658800
Time line 0 1 2 3 4 5 6 7 8 9 10
Cost of new machine -26000000
Initial working capital -1040000
=Initial Investment outlay -27040000
100.00%
Profits 5658800 5658800 5658800 5658800 5658800 5658800 5658800 5658800 5658800 5658800
-Depreciation (Cost of equipment-salvage value)/no. of years -2500000 -2500000 -2500000 -2500000 -2500000 -2500000 -2500000 -2500000 -2500000 -2500000 1000000 =Salvage Value
=Pretax cash flows 3158800 3158800 3158800 3158800 3158800 3158800 3158800 3158800 3158800 3158800
-taxes =(Pretax cash flows)*(1-tax) 2053220 2053220 2053220 2053220 2053220 2053220 2053220 2053220 2053220 2053220
+Depreciation 2500000 2500000 2500000 2500000 2500000 2500000 2500000 2500000 2500000 2500000
=after tax operating cash flow 4553220 4553220 4553220 4553220 4553220 4553220 4553220 4553220 4553220 4553220
reversal of working capital 1040000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 650000
+Tax shield on salvage book value =Salvage value * tax rate 350000
=Terminal year after tax cash flows 2040000
Total Cash flow for the period -27040000 4553220 4553220 4553220 4553220 4553220 4553220 4553220 4553220 4553220 6593220
Discount factor= (1+discount rate)^corresponding period 1 1.14 1.2996 1.481544 1.6889602 1.9254146 2.1949726 2.502268791 2.8525864 3.251948521 3.707221
Discounted CF= Cashflow/discount factor -27040000 3994052.632 3503554.94 3073293.807 2695871.8 2364799.8 2074385.8 1819636.65 1596172.5 1400151.316 1778480
NPV= Sum of discounted CF= -2739600.55

jeff jeffy answered 4 months ago
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