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 $1.95 million fully installed and has a 10 year life. It will be depreciated to a book value of $138,277.00 and sold for that amount in year 10.

b. The Engineering Department spent $19,538.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $24,386.00.

d. The PJX5 will reduce operating costs by $409,126.00 per year.

e. CSD’s marginal tax rate is 30.00%.

f. CSD is 65.00% equity-financed.

g. CSD’s 13.00-year, semi-annual pay, 5.88% coupon bond sells for $958.00.

h. CSD’s stock currently has a market value of $23.45 and Mr. Bensen believes the market estimates that dividends will grow at 2.05% forever. Next year’s dividend is projected to be $1.64.

Answer 1

IRR is the internal rate of return at which present value of cash flows are equal to initial investment.

initial investment = year 1 cash flow/(1+IRR) + year 2 cash flow/(1+IRR)2 + year 3 cash flow/(1+IRR)3 .... + year 10 cash flow/(1+IRR)10

tax on sale of PJX5 = (sale value - book value)*tax rate = ($138,277 - $138,277)*30% = $0*30% = $0

the IRR of the PJX5 is 11.94%.

	Years	0	1	2	3	4	5	6	7	8	9	10	Total
	Cost of PJX5	-$1,950,000	0	0	0	0	0	0	0	0	0	0	-$1,950,000
	Cost of plant floor	-$24,386	0	0	0	0	0	0	0	0	0	0	-$24,386
	reduction in operating costs	$0	$409,126	$409,126	$409,126	$409,126	$409,126	$409,126	$409,126	$409,126	$409,126	$409,126	$4,091,260
Less:	Depreciation	$0	$181,172	$181,172	$181,172	$181,172	$181,172	$181,172	$181,172	$181,172	$181,172	$181,172	$1,811,723
	Pre-tax cash flow	$0	$227,954	$227,954	$227,954	$227,954	$227,954	$227,954	$227,954	$227,954	$227,954	$227,954	$2,279,537
Less:	Taxes @30%	$0	$68,386	$68,386	$68,386	$68,386	$68,386	$68,386	$68,386	$68,386	$68,386	$68,386	$683,861
	After-tax cash flow	$0	$159,568	$159,568	$159,568	$159,568	$159,568	$159,568	$159,568	$159,568	$159,568	$159,568	$1,595,676
Add back:	Depreciation	$0	$181,172	$181,172	$181,172	$181,172	$181,172	$181,172	$181,172	$181,172	$181,172	$181,172	$1,811,723
Add:	Sale of equipment	$0	$0	$0	$0	$0	$0	$0	$0	$0	$0	$138,277	$138,277
Less:	Tax on equip. sale	$0	$0	$0	$0	$0	$0	$0	$0	$0	$0	$0	$0
	Operating cash flow	-$1,974,386	$340,740	$340,740	$340,740	$340,740	$340,740	$340,740	$340,740	$340,740	$340,740	$479,017	$1,571,290
	IRR	11.94%

Calculation