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 $1.67 million fully installed and has a 10 year life. It will be depreciated to a book value of $154,643.00 and sold for that amount in year 10. b. The Engineering Department spent $42,725.00 researching the various juicers. c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $17,644.00. d. The PJX5 will reduce operating costs by $439,063.00 per year. e. CSD’s marginal tax rate is 24.00%. f. CSD is 70.00% equity-financed. g. CSD’s 14.00-year, semi-annual pay, 6.55% coupon bond sells for $1,022.00. h. CSD’s stock currently has a market value of $22.49 and Mr. Bensen believes the market estimates that dividends will grow at 2.50% forever. Next year’s dividend is projected to be $1.76. Please show how to get the cash flows and NPV

Answer 1

Ans.

Calculation of discounting rates as

Cost of Bond = [$ 131 ( 1 - 0.24)] + [($ 1000 - $ 1022)/14]/ [ 1000 + 1022 /2 ]

$ 99.56 -1.57 / $ 1,011 = 9.69%

cost of Equity = $ 1.76 / $ 22.49 + 2.5% = 7.825 % + 2.5% = 10.325% or 10.33%

Cost of Capital = 10.33% * 70% + 9.69 * 30% = 7.231% + 2.907% = 10.138% or 10.14%

Initial Cost = $ 1,670,000 + $ 42,725 + $ 17,644 = $ 1,730,369

PV of cash flows = $ 439,063 * PVAF ( 10.14 % , 10)

= $ 439,063 * 6.10778551176 = $ 2,681,702

PV of salvage value = $ 154,643 * PVIF ( 10.14 % , 10)

= $ 154,643 * 0.38067054907 = $ 58,868

NPV = PV of Cash Inflows - PV of cash Outflows

= [ $ 2,681,702 + $ 58,868 ] - $ 1,730,369

=$ 1,010,201