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 $1.81 million fully installed and has a 10 year life. It will be depreciated to a book value of $201,143.00 and sold for that amount in year 10.

b. The Engineering Department spent $31,074.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $16,544.00.

d. The PJX5 will reduce operating costs by $482,503.00 per year.

e. CSD’s marginal tax rate is 36.00%.

f. CSD is 62.00% equity-financed.

g. CSD’s 15.00-year, semi-annual pay, 5.07% coupon bond sells for $961.00.

h. CSD’s stock currently has a market value of $21.65 and Mr. Bensen believes the market estimates that dividends will grow at 2.08% forever. Next year’s dividend is projected to be $1.54.

PLEASE SHOW USING FINANCIAL CALCULATOR

Answer 1

1.Calculation of NPV

a)cost of Equity(Ke)

stock price=Next year dividen/(Ke-Growth rate)

Ke=(Next year Dividend/stock price)+Growth rate

=($1.54/$21.65)+2.08%

=9.19%

b)After tax Cost of Debt(Kd)

semi-annual rate=5.07%

Annual Rate=5.07*2

=10.14%

After Tax cost of Debt=10.14%(1-36%)

=6.50%

c)WACC

Weight of Equity(We)=62%

Weight of Debt(Wd)=100%-62%

=38%

WACC=Ke*We+Kd*Wd

=9.19%*.62+6.50%*.38

=5.6978%+2.47%

=8.17%

d)Initial Cash Outlay=Equipment cost+Research expense+Redisgning Cost

=$1810,000+$31,074+$16,544

=$1857,618

e)Annual Net Cost Saving in cash

=(Annual Operating Cost Saved-Depreciation)*(1-tax rate)+Depreciation

Depreciation=($1810,000-$201,143)/10

=$160885.70

Annual Net Cost Saving in cash= ($482,503-$160885.70)*(1-.36)+$160885.70

=$366,720.77

Termianl Cash inflow at the end of project=Salvage value of Equipment

=$201,143

Since salvage value is equal to book value,hence it does not attract tax.

NPV is;

=Present value of Annual Net Cost Saving in cash+Present Value of Terminal Cash inflow-Initial cash outlay

Present value of Annual Net Cost Saving in cash=Annual Net Cost Saving in cash*Discounting Factor @WACC for 10Years

=$366,720.77*6.659

=$2441,993.61

Present Value of Terminal Cash inflow=$201,143/(1+.0817)^10

=$201,143*.4560

=$91721.21

Thus NPV is;

=$2441,993.61+$91721.21-$1857,618

=$676,096.82

Thus NPV is $676,096.82