Question

1. 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 $22.00 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 $1.23 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $9.22 million per year and cost $2.03 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 28.00%. The WACC is 11.00%. Find the NPV (net present value).

2.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 $25.00 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 $1.24 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.90 million per year and cost $2.28 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 29.00%. The WACC is 13.00%. Find the IRR (internal rate of return).

Answer 1

1

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

=(9220000-2030000)*(1-0.12)

6327200

Time line		0	1	2	3	4	5	6	7	8	9	10
Cost of new machine		-22000000
Initial working capital		-1230000
=Initial Investment outlay		-23230000
													100.00%
Profits			6327200	6327200	6327200	6327200	6327200	6327200	6327200	6327200	6327200	6327200
-Depreciation	(Cost of equipment-salvage value)/no. of years		-2000000	-2000000	-2000000	-2000000	-2000000	-2000000	-2000000	-2000000	-2000000	-2000000	2000000	=Salvage Value
=Pretax cash flows			4327200	4327200	4327200	4327200	4327200	4327200	4327200	4327200	4327200	4327200
-taxes	=(Pretax cash flows)*(1-tax)		3115584	3115584	3115584	3115584	3115584	3115584	3115584	3115584	3115584	3115584
+Depreciation			2000000	2000000	2000000	2000000	2000000	2000000	2000000	2000000	2000000	2000000
=after tax operating cash flow			5115584	5115584	5115584	5115584	5115584	5115584	5115584	5115584	5115584	5115584
reversal of working capital												1230000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)											1440000
+Tax shield on salvage book value	=Salvage value * tax rate											560000
=Terminal year after tax cash flows												3230000
Total Cash flow for the period		-23230000	5115584	5115584	5115584	5115584	5115584	5115584	5115584	5115584	5115584	8345584
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631	1.5180704	1.6850582	1.8704146	2.076160153	2.3045378	2.558037	2.839421
Discounted CF=	Cashflow/discount factor	-23230000	4608634.234	4151922.734	3740470.931	3369793.6	3035850.1	2735000.1	2463964.06	2219787.4	1999809	2939185
NPV=	Sum of discounted CF=	8034416.91

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