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 $24.00 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 $1.34 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.73 million per year and cost $1.62 million per year over the 10-year life of the project. Marketing estimates 18.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 30.00%. The WACC is 14.00%. Find the NPV (net present value).
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 $27.00 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 $1.06 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $9.09 million per year and cost $2.21 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 26.00%. The WACC is 14.00%. Find the IRR (internal rate of return).
Thanks!
Profit = (revenues-cost)*(1-%age that swtiched)
=(8730000-1620000)*(1-0.18) = 5830200
Time line | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | |||
Cost of new machine | -24000000 | |||||||||||||
Initial working capital | -1340000 | |||||||||||||
=Initial Investment outlay | -25340000 | |||||||||||||
100.00% | ||||||||||||||
Profits | 5830200 | 5830200 | 5830200 | 5830200 | 5830200 | 5830200 | 5830200 | 5830200 | 5830200 | 5830200 | ||||
-Depreciation | (Cost of equipment-salvage value)/no. of years | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | -2200000 | 2000000 | =Salvage Value | |
=Pretax cash flows | 3630200 | 3630200 | 3630200 | 3630200 | 3630200 | 3630200 | 3630200 | 3630200 | 3630200 | 3630200 | ||||
-taxes | =(Pretax cash flows)*(1-tax) | 2541140 | 2541140 | 2541140 | 2541140 | 2541140 | 2541140 | 2541140 | 2541140 | 2541140 | 2541140 | |||
+Depreciation | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | 2200000 | ||||
=after tax operating cash flow | 4741140 | 4741140 | 4741140 | 4741140 | 4741140 | 4741140 | 4741140 | 4741140 | 4741140 | 4741140 | ||||
reversal of working capital | 1340000 | |||||||||||||
+Proceeds from sale of equipment after tax | =selling price* ( 1 -tax rate) | 1400000 | ||||||||||||
+Tax shield on salvage book value | =Salvage value * tax rate | 600000 | ||||||||||||
=Terminal year after tax cash flows | 3340000 | |||||||||||||
Total Cash flow for the period | -25340000 | 4741140 | 4741140 | 4741140 | 4741140 | 4741140 | 4741140 | 4741140 | 4741140 | 4741140 | 8081140 | |||
Discount factor= | (1+discount rate)^corresponding period | 1 | 1.14 | 1.2996 | 1.481544 | 1.6889602 | 1.9254146 | 2.1949726 | 2.502268791 | 2.8525864 | 3.251949 | 3.707221 | ||
Discounted CF= | Cashflow/discount factor | -25340000 | 4158894.737 | 3648153.278 | 3200134.454 | 2807135.5 | 2462399.5 | 2159999.6 | 1894736.495 | 1662049.6 | 1457938 | 2179837 | ||
NPV= | Sum of discounted CF= | 291278.86 |
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