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 $24.00 million. The plant and equipment will be depreciated over 10 years to a book value of $3.00 million, and sold for that amount in year 10. Net working capital will increase by $1.28 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.75 million per year and cost $1.51 million per year over the 10-year life of the project. Marketing estimates 11.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 31.00%. The WACC is 10.00%. Find the NPV (net present value).

Answer 1

Initial cost			=	cost of machine +net working capital
			=	24 m+1.28m
			=	25.8m
Depreciation			=	(cost-book value)/no.of years
			=	(24m-3m)/10
			=	$2.1m per year
annual cash flow			=	[(revenue -cost-depreciation)*(1-tax rate)]+deprecaition
			=	[(8.75m -1.51m-2.1m)*(1-0.31)]+2.1 m
			=	$ 5.6466 m
PV of Annual cash flow			=	PVAF (10%,10 years)*annual cashflow
			=	6.1446*5.6466m
			=	$34.7 m
PV of terminal			=	PVF (10%,10 years)*(salvge value+working capitlrealised)
			=	0.3855*(3m+1.28m)
			=	$ 1.65m
	NPV		=	PV of annual cashflow+PV of terminalcash flow-initial cost
			=	34.7 mm+1.65 m-25 .8 m
			=	$ 10.55 m
Note
The marketing estimate of 11% buyers coming from regular drink will no relevane in question because
sufficient details about that analysis is not given.For eg,if the firm is regular soft drink manufacturer ,what will be
the cash flow loss due to introduction of diet drink.
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