Question

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 $2.29 million fully installed and has a 10 year life. It will be depreciated to a book value of $129,164.00 and sold for that amount in year 10.

b. The Engineering Department spent $31,579.00 researching the various juicers.

c. Portions of the plant floor have been redesigned to accommodate the juicer at a cost of $17,433.00.

d. The PJX5 will reduce operating costs by $476,171.00 per year.

e. CSD’s marginal tax rate is 23.00%.

f. CSD is 71.00% equity-financed.

g. CSD’s 14.00-year, semi-annual pay, 6.13% coupon bond sells for $972.00.

h. CSD’s stock currently has a market value of $20.13 and Mr. Bensen believes the market estimates that dividends will grow at 2.21% forever. Next year’s dividend is projected to be $1.70.

Answer format: Currency: Round to: 2 decimal places.

Thank You. would be great if you could show all steps (not excel) for better understanding~

Answer 1

Compute the annual depreciation, using the equation as shown below:

Annual depreciation = (Purchase cost – Salvage value)/ Estimated life

                                = ($2,290,000 - $129,164)/ 10 years

                                  = $216,083.60

Hence, the annual depreciation is $216083.60.

Compute the initial investment, using the equation as shown below:

Initial investment = Equipment cost + Researching cost + Plant floor cost

                             = $2,290,000 + $31,579 + $17,433

                             = $2,339,012

Hence, the initial investment is $2,339,012.

Compute the annual savings after-tax, using the equation as shown below:

Annual savings = {Savings in operating cost*(1 – Tax rate)} + (Depreciation*Tax rate)

                          = {$476,171*(1 – 0.23)} + ($216,083.60*23%)

                          = $366,651.67 + 49,699.23

                          = $416,350.90

Hence, the annual savings after tax is $416,350.90.

Compute the pre-tax cost of debt (kd), using the equation as shown below:

Kd = [Interest + {(Maturity value – Redemption value)/ Number of periods}]/ {(Maturity value + Redemption value)/2}

      = [($1,000*6.13%) + {($1,000 – $972)/ 10}]/ {($1,000 + $972)/2}

      = ($61.30 + $2)/ $986

      = 6.501014%

Hence, the pre-tax Kd is 6.501014%.

Compute the after-tax Kd, using the equation as shown below:

Post-tax Kd = Pre-tax kd*(1 – Tax rate)

                    = 6.501014%*(1 – 0.23)

                    = 5.005781%

Hence, the post-tax kd is 5.005781%.

Compute the cost of equity (Ke), using the equation as shown below:

Ke = (Next year dividend/ Market price) + Growth rate

      = ($1.70/ $20.13) + 2.21%

      = 10.655107%

Hence, Ke is 10.655107%.

Compute the weighted average cost of capital (WACC), using the equation as shown below:

WACC = (Kd*Debt percentage) + (Ke*Equity percentage)

             = (5.005781%*29%) + (10.655107%*71%)

             = 1.451676% + 7.565126%

             = 9.016802%

Hence, the WACC is 9.016802%.

Compute the PVIF at 9.016802% and 10 years, using the equation as shown below:

PVIF = 1/ (1 + Rate)^{Number of periods}

              = 1/ (1 + 0.09016802)¹⁰

         = 0.4218

Hence, the PVIF at 9.016802% and 10 years is 0.4218.

Compute the PVIFA at 9.016802% and 10 years, using the equation as shown below:

PVIFA = {1 – (1 + Rate)^{-Number of periods}}/ Rate

                   = {1 – (1 + 0.09016802)^-10}/ 9.016802%

            = (1 – 0.4218)/ 9.016802%

            = 6.4129

Hence, the PVIFA at 9.016802% and 10 years is 6.4129.

Compute the present value (PV) of inflows, using the equation as shown below:

PV = (Annual after-tax Savings*PVIFA_{9.016802%, 10}) + (Salvage value**PVIF_{9.016802%, 10})

      = ($416,350.90*6.4129) + ($129,164*0.4218)

      = $2,724,498.06

Hence, the PV of inflows is $2,724,498.06.

Compute the net present value (NPV), using the equation as shown below:

NPV = PV of inflows – Initial investment

         = $2,724,498.06 - $2,339,012

        = $385,486.06

Hence, the NPV of the project is $385,486.06.