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 $1.91 million fully installed and has a 10 year life. It will be depreciated to a book value of $179,866.00 and sold for that amount in year 10.

b. The Engineering Department spent $13,734.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $16,249.00.

d. The PJX5 will reduce operating costs by $446,978.00 per year.

e. CSD’s marginal tax rate is 34.00%.

f. CSD is 62.00% equity-financed.

g. CSD’s 16.00-year, semi-annual pay, 5.44% coupon bond sells for $1,022.00.

h. CSD’s stock currently has a market value of $21.81 and Mr. Bensen believes the market estimates that dividends will grow at 2.62% forever. Next year’s dividend is projected to be $1.51.

Answer 1

Cash-outflow at year 0:

Cost of Machine = $1,910,000

Research cost = $13,734

Redesigning cost = $16,249.00

Total costs at year 0 =$1,910,000 + $13,734 + $16,249.00

Total costs at year 0 = $1939983

Yearly Cash inflow (savings due to decrease in operating cost) = $446,978.00

Marginal Tax Rate = 34%

Yearly cash-flow after tax = 446,978(1-t) = 446,978(1-0.34)

Yearly cash-flow after tax = $295005.48

Yearly cash-flow from year 1-10 = $295005.48

Salvage value (cash-inflow) in year 10 = $179,866.00

Net cash-flow in year 10 = $295005.48+$179,866.00 = $474871.48

Year	Cash-flow
0	-1939983
1	295005.48
2	295005.48
3	295005.48
4	295005.48
5	295005.48
6	295005.48
7	295005.48
8	295005.48
9	295005.48
10	474871.48

We calculate the IRR using IRR function in excel

IRR = IRR(All-cash flows)

Hence, IRR of the PJX5 = 9.33%