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 $26.00 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 $8.82 million per year and cost $2.13 million per year over the 10-year life of the project. Marketing estimates 11.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 34.00%. The WACC is 13.00%. Find the NPV (net present value).

Answer 1

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

=(8820000-2130000)*(1-0.11)

=5954100

Time line		0	1	2	3	4	5	6	7	8	9	10
Cost of new machine		-26000000
Initial working capital		-1240000
=Initial Investment outlay		-27240000
													100.00%
Profits			5954100	5954100	5954100	5954100	5954100	5954100	5954100	5954100	5954100	5954100
-Depreciation	(Cost of equipment-salvage value)/no. of years		-2400000	-2400000	-2400000	-2400000	-2400000	-2400000	-2400000	-2400000	-2400000	-2400000	2000000	=Salvage Value
=Pretax cash flows			3554100	3554100	3554100	3554100	3554100	3554100	3554100	3554100	3554100	3554100
-taxes	=(Pretax cash flows)*(1-tax)		2345706	2345706	2345706	2345706	2345706	2345706	2345706	2345706	2345706	2345706
+Depreciation			2400000	2400000	2400000	2400000	2400000	2400000	2400000	2400000	2400000	2400000
=after tax operating cash flow			4745706	4745706	4745706	4745706	4745706	4745706	4745706	4745706	4745706	4745706
reversal of working capital												1240000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)											1320000
+Tax shield on salvage book value	=Salvage value * tax rate											680000
=Terminal year after tax cash flows												3240000
Total Cash flow for the period		-27240000	4745706	4745706	4745706	4745706	4745706	4745706	4745706	4745706	4745706	7985706
Discount factor=	(1+discount rate)^corresponding period	1	1.13	1.2769	1.442897	1.6304736	1.8424352	2.0819518	2.35260548	2.6584442	3.004042	3.394567
Discounted CF=	Cashflow/discount factor	-27240000	4199739.823	3716583.914	3289012.313	2910630.4	2575779.1	2279450.5	2017212.847	1785144.1	1579774	2352496
NPV=	Sum of discounted CF=	-534177.53