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 $2.20 million fully installed and has a 10 year life. It will be depreciated to a book value of $243,320.00 and sold for that amount in year 10.

b. The Engineering Department spent $39,147.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $20,225.00.

d. The PJX5 will reduce operating costs by $453,365.00 per year.

e. CSD’s marginal tax rate is 33.00%.

f. CSD is 68.00% equity-financed.

g. CSD’s 14.00-year, semi-annual pay, 5.80% coupon bond sells for $978.00.

h. CSD’s stock currently has a market value of $23.87 and Mr. Bensen believes the market estimates that dividends will grow at 2.46% forever. Next year’s dividend is projected to be $1.45.

round 2 decimals

Answer 1

Calculation of Weighted average cost of capital

cost of equity= next year's dividend/share price +dividend growth rate

= $1.45/$23.87+2.46℅

=8.53%

WACC= cost of equity*weight+cost of debt*weight

= 8.53%*0.68+5.80%*(1-.33)*.32

= 5.80+ 1.24

= 7.04%

Depreciation on PJX5 = 2200000-243320/10

= $195668 p. a.

Tax saved on depreciation= $195668*(1-.33)

=$ 64570 p. a.

Calculation of Net present value

Particulars Year Amount PVF Present value

@7.04%

PJX 5 0 $2200000 1 (2200000) Rsearch exp. 0 $39147 1 ( 39147)

Redesign cost 0 $20225 1 (20225)

Reduce operating 1-10 $453365*.67

(Cost net of tax) = $303754.55 7.01 2129319

Tax saved on dep 1-10 $64570 7.01 452635.70

Salvage value 10 $ 243320 0.506  123119.92

Net present value $445702.62