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 NPV of the PJX5?

a. The PJX5 will cost $1.74 million fully installed and has a 10 year life. It will be depreciated to a book value of $196,319.00 and sold for that amount in year 10.

b. The Engineering Department spent $19,768.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $18,099.00.

d. The PJX5 will reduce operating costs by $313,682.00 per year.

e. CSD’s marginal tax rate is 27.00%.

f. CSD is 70.00% equity-financed.

g. CSD’s 14.00-year, semi-annual pay, 5.56% coupon bond sells for $1,045.00.

h. CSD’s stock currently has a market value of $24.94 and Mr. Bensen believes the market estimates that dividends will grow at 2.66% forever. Next year’s dividend is projected to be $1.68.

CAN SOMEONE PLEASE ANSWER THIS QUESTION IN SIMPLE STEPS AS FAR AS BREAKING IT DOWN

THANK YOU!

Answer 1

Given

PJX5 Cost = 1,740,000 dollars

Reasearch Cost incurred by engineering department = 19,768 dollars

Additional costs that are incurred to redesign plant floor = 18,099 dollars

THE TOTAL COST OF INVESTEMENT IN THIS PROJECT AT YEAR 0 OR NOW WILL BE

=1,740,000 + 19,768 + 18,099

= 1,777,867 dollars

DEPRECIATION WILL BE CALCULATED AS UNDER

Terminal Value = 196,319 dollars

=(Total Cost - Terminal Value) / Estimated Life of the asset

=(1,777,867 - 196,319) / 10

=1,581,548 / 10

= 158,154.8 dollars every year for ten years.

CALCULATION OF WEIGHTED AVERAGE COST OF CAPITAL(WACC) FOR FINDING DISCOUNT FACTOR TO CALCULATE NPV

Before calculating WACC, we have to first find the cost of equity and cost of debt

Cost of Equity:

Using Gordans growth model

Ke = (D1/Po) + g

where Ke = Cost of Equity

D1 = Projected Dividend to be paid in next years which is given as = 1.68 dollars

Po = Current Market price of the equity share = 24.94 dollars

g = Growth = 2.66% or 0.0266

Ke = (1.68/24.94) + 0.0266

= 0.093962 0r 9.3962%

COST OF EQUITY = 9.3962%

COST OF DEBT

The effective Interest that will be paid on bond will be as follows

For first 6months = 1000*5.56% * 6/12 = 28 and for next 6 months also it will be same that is 28 dollars

Total Interest Paid by Company in the year will be = 28+28 = 56

Effective Interest rate would be = (Interest paid in year / Face Value of bond )*100 = (56/1000)*100 = 5.6%

COST OF DEBT BEFORE TAX = 5.6%

After Tax Cost of Debt = Cost of Debt *(1-tax rate)

Tax Rate = 27%

COST OF DEBT AFTER TAX = 5.6% * (1-27%) = 4.088%

WEIGHTED AVERAGE COST OF CAPITAL

PARTICULARS	WEIGHTS (a)	COST (b)	WIGHTED AVERAGE COST OF CAPITAL (a)*(b)
Equity	0.7	9.40%	0.0657734
Debt	0.3	4.09%	0.012264
TOTAL	1		0.0780374
WACC	7.8037%

NET PRESENT VALUE WILL BE CALCULATED AS FOLLOWS

CALCULATING CASH FLOWS
PARTICULARS	AMOUNT (IN DOLLARS)
Decrease in Operating Cost by	313682
Less: Depreciation	-158154.80
EBIT	155527.2
Less:Interest	-28000
EBT	127527.2
Less:Taxes at 27%	-34432.344
PAT	93094.856
PAT	93094.856
Add: Interest*(1-Tax)	20440.00
UNLEVERED INCOME	113534.86
Add:Non Cash Expenditure	158154.80
FREE CASH FLOW	271689.66

YEAR	CASH FLOWS	DISCOUNT FACTOR @ 7.8037%	PRESENT VALUE
0	-1777867	1	-1777867
1	271689.66	0.927611602	252022.4771
2	271689.66	0.860463285	233778.9738
3	271689.66	0.798175726	216856.0885
4	271689.66	0.740397064	201158.2238
5	271689.66	0.686800907	186596.7023
6	271689.66	0.63708449	173089.266
7	271689.66	0.590966965	160559.6114
8	271689.66	0.548187813	148936.9584
9	271689.66	0.508505376	138155.6506
10	468008.66	0.471695486	220757.5706
NET PRESENT VALUE	154044.5224

For the purpose of Interest Calulation, since Number of bonds is not mentioned in the question, I have taken company sold 500 bonds which have face value of 1000 dollars

Interest there on will be calulated as =500*1000*5.6% = 28000 dollars.

NET PRESENT VALUE = 154,044.5224 Dollars

NOTE: Please note that the interest is calculated on the assumed number of debentures.