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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 $25.00 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 $1.02 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.52 million per year and cost $1.77 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 26.00%. The WACC is 10.00%. Find the IRR (internal rate of return).

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Expert Solution

Profit = (revenues-variable cost)*(1-switch %)
=(8520000-1770000)*(1-0.14)
=5805000
Time line 0 1 2 3 4 5 6 7 8 9 10
Cost of new machine -25000000
Initial working capital -1020000
=Initial Investment outlay -26020000
Profits 5805000 5805000 5805000 5805000 5805000 5805000 5805000 5805000 5805000 5805000
-Depreciation (Cost of equipment-salvage value)/no. of years -2400000 -2400000 -2400000 -2400000 -2400000 -2400000 -2400000 -2400000 -2400000 -2400000
=Pretax cash flows 3405000 3405000 3405000 3405000 3405000 3405000 3405000 3405000 3405000 3405000
-taxes =(Pretax cash flows)*(1-tax) 2519700 2519700 2519700 2519700 2519700 2519700 2519700 2519700 2519700 2519700
+Depreciation 2400000 2400000 2400000 2400000 2400000 2400000 2400000 2400000 2400000 2400000
=after tax operating cash flow 4919700 4919700 4919700 4919700 4919700 4919700 4919700 4919700 4919700 4919700
reversal of working capital 1020000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 740000
+Tax shield on salvage book value =Salvage value * tax rate 260000
=Terminal year after tax cash flows 2020000
Total Cash flow for the period -26020000 4919700 4919700 4919700 4919700 4919700 4919700 4919700 4919700 4919700 6939700
Discount factor= (1+discount rate)^corresponding period 1 1.141788646 1.303681313 1.488528522 1.699584966 1.9405668 2.2157172 2.529880696 2.8885891 3.298158188 3.7658
Discounted CF= Cashflow/discount factor -26020000 4308765.914 3773698.335 3305076.072 2894647.869 2535187.1 2220364.6 1944637.155 1703149.8 1491650.709 1842822
NPV= Sum of discounted CF= 0.00
IRR is discount rate at which NPV = 0 = 14.18%

jeff jeffy answered 5 months ago
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