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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 $27.00 million. The plant and equipment will be depreciated over 10 years to a book value of $2.00 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 $8.69 million per year and cost $1.84 million per year over the 10-year life of the project. Marketing estimates 19.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 29.00%. The WACC is 13.00%. Find the NPV (net present value).

Solutions

Expert Solution

Profit = (revenues-variable cost)*(1-switch %)
=(8690000-1840000)*(1-0.19)
=5548500
Time line 0 1 2 3 4 5 6 7 8 9 10
Cost of new machine -27000000
Initial working capital -1210000
=Initial Investment outlay -28210000
100.00%
Profits 5548500 5548500 5548500 5548500 5548500 5548500 5548500 5548500 5548500 5548500
-Depreciation (Cost of equipment-salvage value)/no. of years -2500000 -2500000 -2500000 -2500000 -2500000 -2500000 -2500000 -2500000 -2500000 -2500000 2000000 =Salvage Value
=Pretax cash flows 3048500 3048500 3048500 3048500 3048500 3048500 3048500 3048500 3048500 3048500
-taxes =(Pretax cash flows)*(1-tax) 2164435 2164435 2164435 2164435 2164435 2164435 2164435 2164435 2164435 2164435
+Depreciation 2500000 2500000 2500000 2500000 2500000 2500000 2500000 2500000 2500000 2500000
=after tax operating cash flow 4664435 4664435 4664435 4664435 4664435 4664435 4664435 4664435 4664435 4664435
reversal of working capital 1210000
+Proceeds from sale of equipment after tax =selling price* ( 1 -tax rate) 1420000
+Tax shield on salvage book value =Salvage value * tax rate 580000
=Terminal year after tax cash flows 3210000
Total Cash flow for the period -28210000 4664435 4664435 4664435 4664435 4664435 4664435 4664435 4664435 4664435 7874435
Discount factor= (1+discount rate)^corresponding period 1 1.13 1.2769 1.442897 1.63047361 1.8424352 2.0819518 2.35260548 2.6584442 3.004041938 3.394567
Discounted CF= Cashflow/discount factor -28210000 4127818.584 3652936.8 3232687.434 2860785.34 2531668.4 2240414.6 1982667.744 1754573.2 1552719.668 2319717
NPV= Sum of discounted CF= -1954011.41

jeff jeffy answered 4 months ago
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