Question

Caspian Sea Drinks is considering the purchase of a plum juicer – the PJX5. There is no planned increase in production. The PJX5 will reduce costs by squeezing more juice from each plum and doing so in a more efficient manner. Mr. Bensen gave Derek the following information. What is the IRR of the PJX5?

a. The PJX5 will cost $1.85 million fully installed and has a 10 year life. It will be depreciated to a book value of $268,795.00 and sold for that amount in year 10.

b. The Engineering Department spent $44,639.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $23,644.00.

d. The PJX5 will reduce operating costs by $344,885.00 per year.

e. CSD’s marginal tax rate is 27.00%.

f. CSD is 62.00% equity-financed.

g. CSD’s 10.00-year, semi-annual pay, 6.96% coupon bond sells for $990.00.

h. CSD’s stock currently has a market value of $20.24 and Mr. Bensen believes the market estimates that dividends will grow at 4.10% forever. Next year’s dividend is projected to be $1.63.

Answer 1

cost of equity	(expected dividend/market price)+growth rate	(1.63/20.24)+4.10%	12.15%
before tax cost of Debt-Using rate function in MS excel	rate(nper,pmt,pv,fv,type) nper =20 pmt =1000*6.96%*1/2 =-34.8 pv =990 fv =-1000 type =0	RATE(20,-34.8,990,-1000,0)	3.55%
after tax annual cost of debt	(3.55*2)*(1-.27)		5.18
WACC
source	weight	component cost	weight*component cost
Debt	0.38	5.18%	0.019684
equity	0.62	12.15%	0.07533
total	1	WACC =sum of weight*component cost	9.50%
cost of investment in Juicer
cost of Juicer	-1850000
cost of redesigning of floor	-23644
total cash outflow at year 0	-1873644
Annual cash flow from year 1-9
annual saving		344885
less annual depreciation =(1850000-268795)/10		158120.5
operating savings		186764.5
after tax savings =operating savings*(1-tax rate)		136338.085
add depreciation		158120.5
annual operating cash flow		294458.585
cash flow in year 10	294458.585+268795	563253.585
Year	cash flow
0	-1873644
1	294458.585
2	294458.585
3	294458.585
4	294458.585
5	294458.585
6	294458.585
7	294458.585
8	294458.585
9	294458.585
10	563253.585
IRR =Using IRR function in MS excel	IRR(B4727:B4737)	10.46%
Yes Juicer should be purchased as it results in IRR more than WACC of 9.5%