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 $1.61 million fully installed and has a 10 year life. It will be depreciated to a book value of $259,504.00 and sold for that amount in year 10.

b. The Engineering Department spent $32,761.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $24,049.00.

d. The PJX5 will reduce operating costs by $437,178.00 per year.

e. CSD’s marginal tax rate is 30.00%.

f. CSD is 56.00% equity-financed.

g. CSD’s 15.00-year, semi-annual pay, 5.80% coupon bond sells for $975.00.

h. CSD’s stock currently has a market value of $21.19 and Mr. Bensen believes the market estimates that dividends will grow at 4.02% forever. Next year’s dividend is projected to be $1.45.

Answer 1

First we have to Calculate Here WACC

WACC = We * Re + ( 1 - We) * Rd * ( 1 - t )

Here We = Weighntage of Equity = 56.00% = 0.56

Re = Cost of Equity

Re = ( D1 / P0 ) + g

D1 = Dividend Expected next Year = 1.45

P0 = Current Year Stock Price =  21.19

g = Dividend Growth = 4.02%

Re = ( D1 / P0 ) + g = ( 1.45/ 21.19) + 4.02% = 10.8628%

t = Tax Rate = 30% = 0.3

Rd = Cost of Debt

Now Cost of Debt will be YTM of the Bond outstanding in Market

Rd =

C = 5.80% of Face Value 1000= 58

F = Face Value = 1000

P = Present Value = 975

n = Periods Out Staanding = 15*2 = 30

So Rd =

= 5.9578% (Here we have used Approximation formula So the value can be differ if we calculate in Ecel)

WACC = We * Re + ( 1 - We) * Rd * ( 1 - t )  

=  0.56 * 10.8628% + ( 1 - 0.56 ) * 5.9578% * ( 1 - 0.3)

= 0.06083 +  0.01835  

=  0.07918 = 7.918%

Cost of PJX5 = $ 1.61 Million =  1610000
Engineering Department spent = 32761

plant floor have been redesigned cost = 24049
Total Investment   = Cost of PJX5 + Engineering Department spent + redesigned cost = 1666,810

Depreciation Calculation :   
Book value after 10 years   259504
Depreciation Each Year = ( Initial Purchase Cost - Salvage Value ) / 10 = (1610000 - 259504) / 10 = 135049.6
Tax Saving Each Year = Depreciation Each Year* Tax Rate = 135049.6 * 30% = 40514.88

PJX5 Sales at Year 10   = 259504

Present Value of Salvage Value = Amount / ( 1 + WACC)^10 =  259504 / ( 1+ 7.918%)^ 10 = 121115.107

Savings due  to   PJX5 m/c =  $437,178.00 per year

Total Savings each Year = Savings due to PJX5 m/c + Tax Saving Each Year = 437,178.00 + 40514.88 = 477,692.88

Present Value of Total Saving Each Year =

Here p = 477,692.88

WACC =  0.07918

N = 10 Years

So

Present Value of Total Saving Each Year =

=  3217222.54

NPV = - Initial Investment + Present Value of Salvage Value + Present Value of Total Saving Each Year

= -1666,810 + 121,115.107 + 3217,222.54 =  1671528

NPV of the PJX5 IS 1671,528 (Ans)