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 IRR of the PJX5?

a. The PJX5 will cost $2.44 million fully installed and has a 10 year life. It will be depreciated to a book value of $211,609.00 and sold for that amount in year 10.

b. The Engineering Department spent $29,031.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $19,864.00.

d. The PJX5 will reduce operating costs by $451,154.00 per year.

e. CSD’s marginal tax rate is 32.00%.

f. CSD is 72.00% equity-financed.

g. CSD’s 19.00-year, semi-annual pay, 6.80% coupon bond sells for $1,015.00.

h. CSD’s stock currently has a market value of $23.13 and Mr. Bensen believes the market estimates that dividends will grow at 3.09% forever. Next year’s dividend is projected to be $1.46.

Answer 1

Ans.

Calculation of discounting rates as

Cost of Bond = [$ 136 ( 1 - 0.32)] + [($ 1000 - $ 1015)/19]/ [ 1000 + 1015 /2 ]

[$ 92.48 - $ 0.789473684 ] / $ 1,007.50 = 9.10%

cost of Equity = $ 1.46 / $ 23.13 + 3.09% = 6.3121 % + 3.09% = 9.4021% or 9.40%

Cost of Capital = 9.10 * 72% + 9.40 * 28% = 6.552% + 2.632% = 9.184% or 9.18%

Initial Cost = $ 2,440,000 + $ 29,031 + $ 19,864 = $ 2,488,895

PV of cash flows = $ 451,154 * PVAF ( 9.18 % , 10)

= $ 451,154 * 6.36712248761 = $ 2,872,553

PV of salvage value = $ 211,609 * PVIF ( 9.18 % , 10)

= $ 211,609 * 0.41549815557 = $ 87,923

NPV = PV of Cash Inflows - PV of cash Outflows

= [ $ 2,872,553 + $ 87,923 ] - $ 2,488,895

=$ 471,581