Question

unanswered not submitted 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 $27.00 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 $1.01 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.89 million per year and cost $2.16 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 28.00%. 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%)

=(8890000-2160000)*(1-0.12)

=5922400

Time line		0	1	2	3	4	5	6	7	8	9	10
Cost of new machine		-27000000
Initial working capital		-1010000
=Initial Investment outlay		-28010000
Profits			5922400	5922400	5922400	5922400	5922400	5922400	5922400	5922400	5922400	5922400
-Depreciation	(Cost of equipment-salvage value)/no. of years		-2600000	-2600000	-2600000	-2600000	-2600000	-2600000	-2600000	-2600000	-2600000	-2600000
=Pretax cash flows			3322400	3322400	3322400	3322400	3322400	3322400	3322400	3322400	3322400	3322400
-taxes	=(Pretax cash flows)*(1-tax)		2392128	2392128	2392128	2392128	2392128	2392128	2392128	2392128	2392128	2392128
+Depreciation			2600000	2600000	2600000	2600000	2600000	2600000	2600000	2600000	2600000	2600000
=after tax operating cash flow			4992128	4992128	4992128	4992128	4992128	4992128	4992128	4992128	4992128	4992128
reversal of working capital												1010000
+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												2010000
Total Cash flow for the period		-28010000	4992128	4992128	4992128	4992128	4992128	4992128	4992128	4992128	4992128	7002128
Discount factor=	(1+discount rate)^corresponding period	1	1.127125311	1.270411467	1.43191292	1.6139453	1.8191186	2.0503746	2.31102912	2.6048194	2.935958	3.309192
Discounted CF=	Cashflow/discount factor	-28010000	4429079.847	3929536.32	3486334.91	3093120.9	2744256.5	2434739.5	2160132.019	1916496.8	1700340	2115963
NPV=	Sum of discounted CF=	0.00
IRR is discount rate at which NPV = 0 =	12.7125%