In: Finance
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 $23.00 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 $1.21 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.65 million per year and cost $2.37 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 33.00%. The WACC is 15.00%. Find the IRR (internal rate of return)
Profit = (revenues-variable cost)*(1-switch %) |
=(8650000-2370000)*(1-0.2) |
=5024000 |
Time line | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | |||
Cost of new machine | -23000000 | |||||||||||||
Initial working capital | -1210000 | |||||||||||||
=Initial Investment outlay | -24210000 | |||||||||||||
100.00% | ||||||||||||||
Profits | 5024000 | 5024000 | 5024000 | 5024000 | 5024000 | 5024000 | 5024000 | 5024000 | 5024000 | 5024000 | ||||
-Depreciation | (Cost of equipment-salvage value)/no. of years | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | 1000000 | =Salvage Value | |
=Pretax cash flows | 2824000 | 2824000 | 2824000 | 2824000 | 2824000 | 2824000 | 2824000 | 2824000 | 2824000 | 2824000 | ||||
-taxes | =(Pretax cash flows)*(1-tax) | 1892080 | 1892080 | 1892080 | 1892080 | 1892080 | 1892080 | 1892080 | 1892080 | 1892080 | 1892080 | |||
+Depreciation | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | ||||
=after tax operating cash flow | 4092080 | 4092080 | 4092080 | 4092080 | 4092080 | 4092080 | 4092080 | 4092080 | 4092080 | 4092080 | ||||
reversal of working capital | 1210000 | |||||||||||||
+Proceeds from sale of equipment after tax | =selling price* ( 1 -tax rate) | 670000 | ||||||||||||
+Tax shield on salvage book value | =Salvage value * tax rate | 330000 | ||||||||||||
=Terminal year after tax cash flows | 2210000 | |||||||||||||
Total Cash flow for the period | -24210000 | 4092080 | 4092080 | 4092080 | 4092080 | 4092080 | 4092080 | 4092080 | 4092080 | 4092080 | 6302080 | |||
Discount factor= | (1+discount rate)^corresponding period | 1 | 1.116310645 | 1.246149456 | 1.391089902 | 1.5528885 | 1.7335059 | 1.9351311 | 2.160207464 | 2.4114626 | 2.691941355 | 3.005043 | ||
Discounted CF= | Cashflow/discount factor | -24210000 | 3665717.978 | 3283779.471 | 2941635.903 | 2635141 | 2360580.3 | 2114626.7 | 1894299.538 | 1696928.7 | 1520122.269 | 2097168 | ||
NPV= | Sum of discounted CF= | 0.00 |
IRR is discount rate at which NPV = 0 = | 11.63% |