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 $28.00 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 $1.31 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.85 million per year and cost $1.91 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 33.00%. The WACC is 12.00%. Find the IRR (internal rate of return).

Submit

Answer format: Percentage Round to: 4 decimal places (Example: 9.2434%, % sign required. Will accept decimal format rounded to 6 decimal places (ex: 0.092434))

Answer 1

Profit = (revenues-sales)*(1-switch%)

=(8850000-1910000)*(1-0.15)

=5899000

Time line		0	1	2	3	4	5	6	7	8	9	10
Cost of new machine		-28000000
Initial working capital		-1310000
=Initial Investment outlay		-29310000
Profits			5899000	5899000	5899000	5899000	5899000	5899000	5899000	5899000	5899000	5899000
-Depreciation	(Cost of equipment-salvage value)/no. of years		-2500000	-2500000	-2500000	-2500000	-2500000	-2500000	-2500000	-2500000	-2500000	-2500000
=Pretax cash flows			3399000	3399000	3399000	3399000	3399000	3399000	3399000	3399000	3399000	3399000
-taxes	=(Pretax cash flows)*(1-tax)		2277330	2277330	2277330	2277330	2277330	2277330	2277330	2277330	2277330	2277330
+Depreciation			2500000	2500000	2500000	2500000	2500000	2500000	2500000	2500000	2500000	2500000
=after tax operating cash flow			4777330	4777330	4777330	4777330	4777330	4777330	4777330	4777330	4777330	4777330
reversal of working capital												1310000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)											2010000
+Tax shield on salvage book value	=Salvage value * tax rate											990000
=Terminal year after tax cash flows												4310000
Total Cash flow for the period		-29310000	4777330	4777330	4777330	4777330	4777330	4777330	4777330	4777330	4777330	9087330
Discount factor=	(1+discount rate)^corresponding period	1	1.112627089	1.237939039	1.377364509	1.5324931	1.7050933	1.897133	2.110801558	2.348535	2.613044	2.907343
Discounted CF=	Cashflow/discount factor	-29310000	4293738.709	3859099.559	3468457.309	3117358.3	2801799.8	2518184	2263277.655	2034174.5	1828263	3125648
NPV=	Sum of discounted CF=	0.00
IRR is discount rate at which NPV = 0 =	11.0000%