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 $2.43 million fully installed and has a 10 year life. It will be depreciated to a book value of $101,124.00 and sold for that amount in year 10.

b. The Engineering Department spent $14,696.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $20,383.00.

d. The PJX5 will reduce operating costs by $434,467.00 per year.

e. CSD’s marginal tax rate is 30.00%.

f. CSD is 58.00% equity-financed.

g. CSD’s 11.00-year, semi-annual pay, 5.01% coupon bond sells for $1,006.00.

h. CSD’s stock currently has a market value of $24.87 and Mr. Bensen believes the market estimates that dividends will grow at 2.34% forever. Next year’s dividend is projected to be $1.79.

ROUND TO 2 DECIMAL PLACES. THANK YOU IN ADVANCE.

Answer 1

Operating cash flow (OCF) each year = incremental income after tax + depreciation

The redesign of plant floor is added to the installed cost of the juicer as it is a capital expenditure. The total depreciable cost = installed cost of juicer + cost of redesign of plant floor.

Depreciation each year = (total depreciable cost - salvage value) / depreciable life = ($2,450,383 - $101,124) / 10 = $234,926

The amount spent by Engineering Department on research is a sunk cost because it is a historical cost, and is not recoverable. It is not incremental to acceptance of the project. Hence, it should not be considered in the cash flow analysis.

The salvage value of the juicer at the end of 10 years equals its book value at the end of 10 years. Hence, there is no tax adjustment required.

IRR is calculated using IRR function in Excel

IRR is 8.97%

D E F G H I J K L ol 10 2 Initial Investment 3 Installed cost of juicer 4 Redesign of plant floor 5 Total depreciable cost $2,430,000 $20,383 $2,450,383 6 7 OCF 8 Reduction in operating costs 9 - Depreciation 10 Incremental earnings before tax 11 - Taxes 12 Incremental earnings after tax 13 + Depreciation 14 OCF 15 16 Terminal Cash Flow 17 Salvage Value 18 19 NPV Analysis 20 Project Cash Flows $434,467 $434,467 $434,467 $434,467 $434,467 $234,926 $234,926 $234,926 $234,926 $234,926 $199,541 $199,541 $199,541 $199,541 $199,541 $59.862' $59.862' $59,862' $59,862' $59,862 $139,679 $139,679 $139,679 $139,679 $139,679 $234,926 $234,926 $234,926 $234,926 $234,926 $374,605 $374,605 $374,605 $374,605 $374,605 $434,467 $234,926 $199,541 $59,862 $139,679 $234,926 $374,605 $434,467 $234,926 $199,541 $59,862 $139,679 $234,926 $374,605 $434,467 $234,926 $199,541 $59,862 $139,679 $234,926 $374,605 $434,467 $234,926 $199,541 $59,862 $139,679 $234,926 $374,605 $434,467 $234,926 $199,541 $59,862 $139,679 $234,926 $374,605 $ 101,124 ($2,450,383) $374,605 $374,605 $374,605 $374,605 $374,605 $374,605 $374,605 $374,605 $374,605 $475,729 8.97% 22 IRR 23