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 $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).
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% |