A new plant to produce tractor gears requires an initial investment of $10 milli

Question

A new plant to produce tractor gears requires an initial investment of $10 million. It is expected that a supplemental investment of $4 million will be needed every 3 years to update the plant. The plant is expected to start producing gears 2 years after the initial investment is made (at the start of the third year). Revenues of $5 million per year are expected to begin to flow at the start of the fourth year. Annual operating and maintenance costs are expected to be S2 million per year. The plant has a 15-year life. List the annual cash flows. What is the NPV of the investment described in Problem 8.13 if the interest rate is 3% per year, compounded annually?

Explanation / Answer

CF i represents the cash flow of ith year. Since initial investment is an outflow, so CF0 = -10 million. Since plant starts producing after 2 years so CF1 = CF2 = 0. The cash flows will be like this...(Net Inflow = Revenue - Investment - operating cost. for each year)

Year Cashflow Revenue Investment Operating costs Net inflow 0 CF0 0.00 10000000.00 0.00 -10000000.00 1 CF1 0.00 0.00 0.00 0.00 2 CF2 0.00 0.00 0.00 0.00 3 CF3 0.00 4000000.00 2000000.00 -6000000.00 4 CF4 5000000.00 0.00 2000000.00 3000000.00 5 CF5 5000000.00 0.00 2000000.00 3000000.00 6 CF6 5000000.00 4000000.00 2000000.00 -1000000.00 7 CF7 5000000.00 0.00 2000000.00 3000000.00 8 CF8 5000000.00 0.00 2000000.00 3000000.00 9 CF9 5000000.00 4000000.00 2000000.00 -1000000.00 10 CF10 5000000.00 0.00 2000000.00 3000000.00 11 CF11 5000000.00 0.00 2000000.00 3000000.00 12 CF12 5000000.00 4000000.00 2000000.00 -1000000.00 13 CF13 5000000.00 0.00 2000000.00 3000000.00 14 CF14 5000000.00 0.00 2000000.00 3000000.00 15 CF15 5000000.00 4000000.00 2000000.00 -1000000.00

NPV = CF0 + CF1/(1.03) + CF2/(1.03)^2 + .... + CF15/(1.03)^15 = $48465.05

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