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 $1.65 million fully installed and has a 10 year life. It will be depreciated to a book value of $111,869.00 and sold for that amount in year 10.

b. The Engineering Department spent $12,195.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $21,299.00.

d. The PJX5 will reduce operating costs by $324,702.00 per year.

e. CSD’s marginal tax rate is 20.00%.

f. CSD is 64.00% equity-financed.

g. CSD’s 16.00-year, semi-annual pay, 5.61% coupon bond sells for $1,007.00.

h. CSD’s stock currently has a market value of $22.81 and Mr. Bensen believes the market estimates that dividends will grow at 3.46% forever. Next year’s dividend is projected to be $1.70.

Answer Format: Percentage Round to: 2 decimal places (Example: 9.24%, % sign required. Will accept decimal format rounded to 4 decimal places (ex: 0.0924))

Answer 1

Formula	Year (n) (Numbers in $000's)	0	1	2	3	4	5	6	7	8	9	10
	Initial investment (I)	(1,650)
	Savings in operating cost ('S)		324.70	324.70	324.70	324.70	324.70	324.70	324.70	324.70	324.70	324.70
(Price of juicer - selling price) = accumulated depreciation; Depreciation/year = accumulated dep./10	Depreciation (D)		(153.81)	(153.81)	(153.81)	(153.81)	(153.81)	(153.81)	(153.81)	(153.81)	(153.81)	(153.81)
(S-D)	Operating profit (OP)		170.89	170.89	170.89	170.89	170.89	170.89	170.89	170.89	170.89	170.89
20%*OP	Tax @20%		(34.18)	(34.18)	(34.18)	(34.18)	(34.18)	(34.18)	(34.18)	(34.18)	(34.18)	(34.18)
(OP-Tax)	After-tax profit (P)		136.71	136.71	136.71	136.71	136.71	136.71	136.71	136.71	136.71	136.71
	Add: depreciation (D)		153.81	153.81	153.81	153.81	153.81	153.81	153.81	153.81	153.81	153.81
(P+D)	OCF		290.52	290.52	290.52	290.52	290.52	290.52	290.52	290.52	290.52	290.52
Since it is sold at Book Value, no tax will be paid.	After-tax salvage value (SV)											111.87
(II+OCF+SV)	FCF	(1,650)	290.52	290.52	290.52	290.52	290.52	290.52	290.52	290.52	290.52	402.39
	IRR	12.40%

IRR = 12.40% (calculated using IRR function in excel)

Note: Research cost and plant floor renovation cost will not be included in the FCF since they are sunk costs.