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 $2.00 million, and sold for that amount in year 10. Net working capital will increase by $1.07 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $9.23 million per year and cost $1.52 million per year over the 10-year life of the project. Marketing estimates 13.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 21.00%. The WACC is 11.00%. Find the IRR (internal rate of return).
Initial Investment = $23,000,000
Salvage Value = $2,000,000
Useful Life = 10 years
Annual Depreciation = (Initial Investment - Salvage Value) /
Useful Life
Annual Depreciation = ($23,000,000 - $2,000,000) / 10
Annual Depreciation = $2,100,000
Initial Investment in NWC = $1,070,000
Salvage Value = $2,000,000
Annual Operating Cash Flow = (Sales - Costs) * (1 - tax) + tax *
Depreciation
Annual Operating Cash Flow = ($9,230,000 - $1,520,000) * (1 - 0.21)
+ 0.21 * $2,100,000
Annual Operating Cash Flow = $7,710,000 * 0.79 + 0.21 *
$2,100,000
Annual Operating Cash Flow = $6,531,900
Let IRR be i%
NPV = -$23,000,000 - $1,070,000 + $6,531,900 * PVA of $1 (i%,
10) + $1,070,000 * PV of $1 (i%, 10) + $2,000,000 * PV of $1 (i%,
10)
0 = -$23,000,000 - $1,070,000 + $6,531,900 * PVA of $1 (i%, 10) +
$1,070,000 * PV of $1 (i%, 10) + $2,000,000 * PV of $1 (i%, 10)
Using financial calculator, i = 24.44%
IRR of the project is 24.44%
Caspian Sea Drinks is considering the production of a diet drink. The expansion of the plant...
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