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 $1.70 million fully installed and has a 10 year life. It will be depreciated to a book value of $123,084.00 and sold for that amount in year 10.

b. The Engineering Department spent $15,514.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $16,345.00.

d. The PJX5 will reduce operating costs by $337,668.00 per year.

e. CSD’s marginal tax rate is 27.00%.

f. CSD is 73.00% equity-financed.

g. CSD’s 20.00-year, semi-annual pay, 5.04% coupon bond sells for $1,045.00.

h. CSD’s stock currently has a market value of $22.12 and Mr. Bensen believes the market estimates that dividends will grow at 3.78% forever. Next year’s dividend is projected to be $1.68.

Round to: 2 decimal places.

Answer 1

Calculation of discounting rate:

Cost of bond = [Coupon Int * (1 - Tax Rate) + (Face Value - Market Price / Duration)] / (Face Value + Market Price / 2)

= 100.8 * (1 - 0.27) + (1000 - 1045 / 20) / (1000 + 1045 / 2)

= 73.58 - 2.25 / 1022.5

= 71.33 / 1022.5

= 0.0697 or 6.97%

Cost of equity = (Next year dividend / Market Value) + Growth Rate

= (1.68 / 22.12) + 0.0378

= 0.0759 + 0.0378

= 0.1137 or 11.37%

Cost of capital = 6.97 * 27% + 11.37 * 73%

= 1.88 + 8.3

= 10.18%

Initial cost = $1,700,000 + $15,514 + $16,345 = $1,731,859

PV of cash flows = $337,668 * PVAF (10.18%, 10 years)

= $337,668 * 6.097

= $2,058,761.80

PV of salvage = $123,084 * PVIF (10.18%, 10 years)

= $123,084 * 0.379

= $46,648.84

NPV = -$1,731,859 + $2,058,761.80 + $46,648.84

= $373,551.64