Question

17.

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 $1.88 million fully installed and has a 10 year life. It will be depreciated to a book value of $156,051.00 and sold for that amount in year 10.

b. The Engineering Department spent $11,645.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $16,538.00.

d. The PJX5 will reduce operating costs by $306,901.00 per year.

e. CSD’s marginal tax rate is 23.00%.

f. CSD is 66.00% equity-financed.

g. CSD’s 15.00-year, semi-annual pay, 5.88% coupon bond sells for $1,029.00.

h. CSD’s stock currently has a market value of $24.51 and Mr. Bensen believes the market estimates that dividends will grow at 4.21% forever. Next year’s dividend is projected to be $1.71.

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#18
Caspian Sea Drinks is considering the production of a diet drink. The expansion of the plant and the purchase of the equipment necessary to produce the diet drink will cost $22.00 million. The plant and equipment will be depreciated over 10 years to a book value of $1.00 million, and sold for that amount in year 10. Net working capital will increase by $1.15 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.94 million per year and cost $1.90 million per year over the 10-year life of the project. Marketing estimates 15.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 35.00%. The WACC is 10.00%. Find the NPV (net present value).

Answer 1

1
Depreciation = Cost - Salvage Value /no. of life
Depreciation=	(1880000-156051)/10
Depreciation=	172395
Now we need to find the WACC from the information given to use as required rate of return
WACC= {kd (1-t)*debt/ debt+ equity}+ {ke*equity/debt+ equity}
So we need to find the cost of equity and cost of debt:
Cost of old Equity	= Dividend for next year/ equity share price+ growth
growth	4.21%
dividend of next yr	1.71
Cost of equity=	=1.71/24.51 +4.21%
	0.070+0.042
	0.112
	11.20%
Cost of Bond
YTM= (C+ (F-P)/n)/(F+P/2)
C= coupon amount= 1000*5.88= 58.8
F= face value=1000
P= Price= 1029
N= tenor= 12
YTM= (58.8+(1000-1029)/15)/(1000+1029/2)
YTM=+56.867/1014.5
YTM= 5.61 %
Particulars	Cost	tax	After tax cost	weight	after tax cost * weights
Bonds	5.61%	23%	=0.056*(1-0.23 )	34%	0.04312 * 0.34	0.014661
0.04312
Equity	11.20%	0%	11.20%	66%	0.1120*0.66	0.07392
			TOTAL			0.088581
WACC is 8.86 %
Now using this as required rate of return we shall compute the NPV
Year	Particulars ( cash flows)	cash flow	Depreciation	profit before tax ( income-dep.)	Tax (23%)	Net profit ( cash flow - tax)	Net Cash Flow ( Net profit after tax + depreciation)	Discounting factor (8.86%)	Discounting factor (8.86%)	Net Present value = NCF * DF
	Initial cost	-18,80,000
		-11,645
		-16,538
	Total cost	-19,08,183								-19,08,183
1	Cost savings	3,06,901	1,72,395	1,34,506	30,936	1,03,570	2,75,965	1/(1+0.0886)^1	0.91861106	253504.13			330356
2	Cost savings	3,06,901	1,72,395	1,34,506	30,936	1,03,570	2,75,965	1/(1+0.0886)^2	0.84384628	232871.7			109017.5
3	Cost savings	3,06,901	1,72,395	1,34,506	30,936	1,03,570	2,75,965	1/(1+0.0886)^3	0.77516653	213918.52
4	Cost savings	3,06,901	1,72,395	1,34,506	30,936	1,03,570	2,75,965	1/(1+0.0886)^4	0.71207654	196507.92
5	Cost savings	3,06,901	1,72,395	1,34,506	30,936	1,03,570	2,75,965	1/(1+0.0886)^5	0.65412139	180514.35
6	Cost savings	3,06,901	1,72,395	1,34,506	30,936	1,03,570	2,75,965	1/(1+0.0886)^6	0.60088314	165822.47
7	Cost savings	3,06,901	1,72,395	1,34,506	30,936	1,03,570	2,75,965	1/(1+0.0886)^7	0.5519779	152326.36
8	Cost savings	3,06,901	1,72,395	1,34,506	30,936	1,03,570	2,75,965	1/(1+0.0886)^8	0.507053	139928.68
9	Cost savings	3,06,901	1,72,395	1,34,506	30,936	1,03,570	2,75,965	1/(1+0.0886)^9	0.4657845	128540.03
10	Cost savings	3,06,901	1,72,395	1,34,506	30,936	1,03,570	2,75,965	1/(1+0.0886)^10	0.42787479	118078.29
									NPV (TOTAL)	-1,26,171
To calculated the cash flow, we need to add back the depreciation ,as it is anon cash expenses.
Net Present Value = Total Cash Inflows from Investments – Cost of Investments
So we can see that NPV= -$1,26,171