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 $2.03 million fully installed and has a 10 year life. It will be depreciated to a book value of $150,477.00 and sold for that amount in year 10.

b. The Engineering Department spent $45,006.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $19,082.00.

d. The PJX5 will reduce operating costs by $347,200.00 per year.

e. CSD’s marginal tax rate is 27.00%.

f. CSD is 63.00% equity-financed.

g. CSD’s 14.00-year, semi-annual pay, 6.71% coupon bond sells for $1,015.00.

h. CSD’s stock currently has a market value of $22.23 and Mr. Bensen believes the market estimates that dividends will grow at 2.97% forever. Next year’s dividend is projected to be $1.73.

(Can you please show me how to solve not just give the answer thank you)

Answer 1

Let us start with calculating the cost of capital for PJX5

Post tax cost of debt = 6.71%*(1-27%) = 4.89%

Current Market Price of Equity = Projected Dividend for next year/(Cost of equity - Dividend growth rate)

Cost of equity = Projected Divident/Current Market Price + Dividend Growth Rate = (1.73/22.23) + 2.97% = 10.75%

Weighted Average Cost of Capital. (WACC) = Post tax cost of debt*(D/D+E) + Cost of Equity*(E/D+E) = 4.89%*(37/100) + 10.75%*(63/100) = 8.58%

So, we have WACC = 8.58%

Annual Depreciation = (2,030,000-150,477)/10 = $ 187,952.3

Assuming 63% of initial cost is equity financed, debt = 2.03*37% = $ 751,100

Annual Interest = 751,100*6.71% = $ 50,398,81

	0	1	2	3	4	5	6	7	8	9	10		Tax	27%
Initial Investment	(20,30,000.00)
Research cost	-												WACC	8.58%
Redesign cost	-
Reduction in operating cost (EBITDA)		3,47,200.00	3,47,200.00	3,47,200.00	3,47,200.00	3,47,200.00	3,47,200.00	3,47,200.00	3,47,200.00	3,47,200.00	3,47,200.00
D&A		1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30
EBIT		1,59,247.70	1,59,247.70	1,59,247.70	1,59,247.70	1,59,247.70	1,59,247.70	1,59,247.70	1,59,247.70	1,59,247.70	1,59,247.70
NOPAT (EBIT*(1-tax))		1,16,250.82	1,16,250.82	1,16,250.82	1,16,250.82	1,16,250.82	1,16,250.82	1,16,250.82	1,16,250.82	1,16,250.82	1,16,250.82
Add: D&A		1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30	1,87,952.30
Salvage Value		-	-	-	-	-	-	-	-	-	1,50,477.00
FCFF	(20,30,000.00)	3,04,203.12	3,04,203.12	3,04,203.12	3,04,203.12	3,04,203.12	3,04,203.12	3,04,203.12	3,04,203.12	3,04,203.12	4,54,680.12
PV	(20,30,000.00)	2,80,164.97	2,58,026.31	2,37,637.05	2,18,858.95	2,01,564.70	1,85,637.04	1,70,967.99	1,57,458.09	1,45,015.74	1,99,621.63
NPV	24,952.46

Research and floor redesign cost has already been incurred and thus should not be considered for NPV calculation as it is sunk cost.

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