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 $1.00 million, and sold for that amount in year 10. Net working capital will increase by $1.29 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.84 million per year and cost $1.50 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 28.00%. The WACC is 14.00%. 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%)

=(8840000-1500000)*(1-0.1)

=6606000

Time line		0	1	2	3	4	5	6	7	8	9	10
Cost of new machine		-26000000
Initial working capital		-1290000
=Initial Investment outlay		-27290000
Profits			6606000	6606000	6606000	6606000	6606000	6606000	6606000	6606000	6606000	6606000
-Depreciation	(Cost of equipment-salvage value)/no. of years		-2500000	-2500000	-2500000	-2500000	-2500000	-2500000	-2500000	-2500000	-2500000	-2500000
=Pretax cash flows			4106000	4106000	4106000	4106000	4106000	4106000	4106000	4106000	4106000	4106000
-taxes	=(Pretax cash flows)*(1-tax)		2956320	2956320	2956320	2956320	2956320	2956320	2956320	2956320	2956320	2956320
+Depreciation			2500000	2500000	2500000	2500000	2500000	2500000	2500000	2500000	2500000	2500000
=after tax operating cash flow			5456320	5456320	5456320	5456320	5456320	5456320	5456320	5456320	5456320	5456320
reversal of working capital												1290000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)											720000
+Tax shield on salvage book value	=Salvage value * tax rate											280000
=Terminal year after tax cash flows												2290000
Total Cash flow for the period		-27290000	5456320	5456320	5456320	5456320	5456320	5456320	5456320	5456320	5456320	7746320
Discount factor=	(1+discount rate)^corresponding period	1	1.156157083	1.3366992	1.545434248	1.7867648	2.0657807	2.388367	2.76132744	3.1925283	3.691064	4.26745
Discounted CF=	Cashflow/discount factor	-27290000	4719358.711	4081935.561	3530606.37	3053742.8	2641287.1	2284540	1975977.177	1709090.6	1478251	1815210
NPV=	Sum of discounted CF=	0.00
IRR is discount rate at which NPV = 0 =	16.0000%