PROBLEM 4 Company VGG is thinking of buying a factory to meet the growing demand

Question

PROBLEM 4

Company VGG is thinking of buying a factory to meet the growing demand for its products. The following is the financial data regarding this proposal.

Cost of the factory today                                 $20 million

Annual cash flow                                           $2 million

Life of the factory                                           15 years

Cost of capital                                     8%

CALCULATE THE FOLLOWING:

Payback period in years

Net present value.

Based on your answer for 1.b above, should the company buy this factory? Why or why not?

Bonus: 5 points

Now assume that after 15 years, the factory can be sold for $12 million. What is the net present value?  

Explanation / Answer

Part 1:

Payback Period = 20/2 = 10 years

NPV = - 20000000 + 2000000/(1+.08)^1 + 2000000/(1+.08)^2 + 2000000/(1+.08)^3 + 2000000/(1+.08)^4 + 2000000/(1+.08)^5 + 2000000/(1+.08)^6 + 2000000/(1+.08)^7 + 2000000/(1+.08)^8 + 2000000/(1+.08)^9 + 2000000/(1+.08)^10 + 2000000/(1+.08)^11 + 2000000/(1+.08)^12 + 2000000/(1+.08)^13 + 2000000/(1+.08)^14 + 2000000/(1+.08)^15 = -2881042.62 or -2881043

Part 2:

No, the factory should not be bought as it is resulting in a negative NPV.

Part 3:

NPV = - 20000000 + 2000000/(1+.08)^1 + 2000000/(1+.08)^2 + 2000000/(1+.08)^3 + 2000000/(1+.08)^4 + 2000000/(1+.08)^5 + 2000000/(1+.08)^6 + 2000000/(1+.08)^7 + 2000000/(1+.08)^8 + 2000000/(1+.08)^9 + 2000000/(1+.08)^10 + 2000000/(1+.08)^11 + 2000000/(1+.08)^12 + 2000000/(1+.08)^13 + 2000000/(1+.08)^14 + 2000000/(1+.08)^15 + 12000000/(1+.08)^15= 901857.84 or 901858

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