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 $248,619.00 and sold for that amount in year 10. b. The Engineering Department spent $19,736.00 researching the various juicers. c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $17,599.00. d. The PJX5 will reduce operating costs by $480,772.00 per year. e. CSD’s marginal tax rate is 34.00%. f. CSD is 74.00% equity-financed. g. CSD’s 12.00-year, semi-annual pay, 6.67% coupon bond sells for $1,012.00. h. CSD’s stock currently has a market value of $23.69 and Mr. Bensen believes the market estimates that dividends will grow at 3.34% forever. Next year’s dividend is projected to be $1.42.

Answer format: Currency: Round to: 4 decimal places. Thank You.

Answer 1

Calculation of discount rate (WACC):

WACC = sum of weighted costs

=(cost of equity*74%) + (cost of debt*(1-Tax rate)*26%)

Cost of equity = (next year's dividend/current price) + growth rate = (1.42/23.69) + 3.34% = 9.33%

Cost of debt: FV (par value) = 1,000; PV (current price) = -1,012; PMT (semi-annual coupon) = coupon rate*par value/2 = 6.67%*1,000/2 = 33.35; N (number of coupons) = 12*2 = 24, solve for RATE.

Semi-annual yield = 3.26% so annual yield = 3.26%*2 = 6.52%

WACC = (9.33%*74%) + (6.52%*(1-34%)*26%) = 8.03%

Calculation of cash flows, NPV & IRR:

Note: Expense on redesigning the plant floor is not considered in the cash flows as it is a sunk cost.