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 $2.08 million fully installed and has a 10 year life. It will be depreciated to a book value of $248,744.00 and sold for that amount in year 10.

b. The Engineering Department spent $47,451.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $23,078.00.

d. The PJX5 will reduce operating costs by $425,909.00 per year.

e. CSD’s marginal tax rate is 30.00%.

f. CSD is 73.00% equity-financed.

g. CSD’s 16.00-year, semi-annual pay, 5.86% coupon bond sells for $1,022.00.

h. CSD’s stock currently has a market value of $21.60 and Mr. Bensen believes the market estimates that dividends will grow at 3.89% forever. Next year’s dividend is projected to be $1.61.

Answer 1

Answer:

Calculation of WACC:

Equity:

Cost of equity = (Dividend next year / Share price) + Growth rate = (1.61 / 21.60) + 3.89% = 11.3437%

Debt:

CSD’s 16.00-year, semi-annual pay, 5.86% coupon bond sells for $1,022.00.

Semiannual coupon = 1000 * 5.86% /2 = $29.30

Semiannual yield:

= RATE (nper, pmt, pv, fv, type)

= RATE (32, 29.30, -1022, 1000, 0)

= 2.82466%

Cost of debt = 2.82466% * 2 =5.6493%

WACC:

WACC = 11.3437% * 73% + 5.6493% * (1 - 30%) * (1 - 73%)

= 9.35%

WACC = 9.35%

NPV Calculations:

Installed cost = $2,080,000 + $23,078.00 = $2,103,078

Annual depreciation = (Installed cost - Salvage value) / 10 = (2103078 - 248744) / 10 = $185,433.4

Annual cash flow (for 10 years) = Reduction in operating cost * (1 - Tax rate) + Depreciation * tax rate

= 425909 * (1 - 30%) + 185433.40 * 30%

= $353,766.32

Terminal value = $248744

NPV = Annual cash flow * PV factor of annuity + Terminal value * PV factor - Initial investment

= 353766.32 * (1 - 1 / (1 + 9.35%) ¹⁰) / 9.35% + 248744 * 1/ (1 + 9.35%) ¹⁰ - 2103078

= $234,468.42

NPV of the PJX5 = $234,468.42