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 $2.47 million fully installed and has a 10 year life. It will be depreciated to a book value of $103,486.00 and sold for that amount in year 10.

b. The Engineering Department spent $32,889.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $24,422.00.

d. The PJX5 will reduce operating costs by $319,372.00 per year.

e. CSD’s marginal tax rate is 26.00%.

f. CSD is 61.00% equity-financed.

g. CSD’s 11.00-year, semi-annual pay, 6.15% coupon bond sells for $969.00.

h. CSD’s stock currently has a market value of $23.57 and Mr. Bensen believes the market estimates that dividends will grow at 3.67% forever. Next year’s dividend is projected to be $1.48.

Answer 1

Answer: 1.research and development cost are sunk cost and not to be included in the calculation of net persent value.

sunk cost are those cost which are incurred in past i.e. before starting of the project.

as per information research cost is 32889 and development cost is floor redesigning cost 24422. so these costs are unrelevvant cost and not to be consider.

2. reduction of cost is also a part of cash inflow adn hence will be considered as cash inflow

3. depreciation for the year will be: (cost- salvage value)/ useful life of asset.

                             (2470000-103486) / 10 = 236651.4 per year

there will be no ,profit on sale of pplant at the end of useful life because plant will sold at the salvage value(book value at the end of the 10th year). so tax will be levied.

4. Apportionment of equity fund and borrowed fund in total finance:

total finance: 2470000

equity fund 61% = 2470000 * 61% =1506700

borrowed fund 39%(100-61)= 963300

interest on borrwed fund actually interest is paid on par value and we can assume par value 1000

number of bonds issued = 963300 / 969 = 995 bonds

par value of bonds will be 995 * 1000 = 995000.

interest on bonds for a year will be 995000 * 6.15% = 61192.5

5. number of shares issued on financing equity = 1506700 / 23.57 = 63925 shares (approx)

formula used : total equity value / market value per share.

6. dividend will be paid with growth rate 3.67%.

dividend for first = 1.48 * number fo shares = 1.48 * 63925 = 94609. this amount will grow by 3.67% every year.

7. nothing has been mentioned about repayment of borrowed amount: so there is no outflow of principal amount.

8. cash outflow at the beginning of the will be nil because there is one side of cash inflow in the form of borrowings and another side purchse of plant of the same amount.

9. cost of capital is not given in question so we not able to calculate present value but on the other hand there is no cash outflow during the 10 years in the form of repayament of borrowed fund. so there is always positive cash inflow at any cost of capital. so proposal will be acceptable.

all the calculatins have been done in the excel sheet so you can find the attachment detailed calculation.

note : NPV is the difference between cash inflow minus cash outflow.