Question

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 $23.00 million. The plant and equipment will be depreciated over 10 years to a book value of $3.00 million, and sold for that amount in year 10. Net working capital will increase by $1.41 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.57 million per year and cost $2.49 million per year over the 10-year life of the project. Marketing estimates 12.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 32.00%. The WACC is 15.00%. Find the NPV (net present value).

Answer 1

The cash flow in Year 0 is initial investment + investment in working capital

$23 million + $1.41 million

= $24.41 million

The cash flows from year 1 to 10 are:

(Revenue - costs ) * (1 - tax rate ) = ($8.57 - $2.49 ) * (1-0.32)

=$6.08 *0.68

=$4.1344

so, CF0 = ($24.41)

CF1 TO CF9 = $4.1344

CF10 = $4.1344 + 1.41 +3

= 8.5444 ( CF9 + RECOVERY OF WORKING CAPITAL INVESTMENT + AFTER TAX SALVAGE VALUE )

AFTER TAX SALVAGE VALUE = MV -  (MV - BV) * (1- TAX RATE)

= $3.

I/Y = 15%

NPV = -$2.5703.

= -$2.57 (ROUNDED OFF TO TWO DECIMAL PLACES)