Question

Caspian Sea Drinks is considering the production of a diet drink. The expansion of the plant and the purchase of the equipment necessary to produce the diet drink will cost $27.00 million. The plant and equipment will be depreciated over 10 years to a book value of $2.00 million, and sold for that amount in year 10. Net working capital will increase by $1.34 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.96 million per year and cost $1.64 million per year over the 10-year life of the project. Marketing estimates 19.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 28.00%. The WACC is 14.00%. Find the IRR (internal rate of return).

Answer Format: Percentage Round to: 4 decimal places (Example: 9.2434%, % sign required. Will accept decimal format rounded to 6 decimal places (ex: 0.092434))

Answer 1

Net cash flow in year 0 = initial investment + increase in working capital

Net cash flow in years 1 to 9 = income after taxes + depreciation

Net cash flow in year 10 = income after taxes + depreciation + recovery of working capital

the percentage of buyers shifting from regular to diet drink is irrelevant for this project

IRR is calculated using the IRR function in Excel, with the inputs of values being the array of cells containing the net cash flows

IRR = 16.7627%