The Yurdone Corporation wants to set up a private cemetery business. According t

Question

The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is “looking up.” As a result, the cemetery project will provide a net cash inflow of $126,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 5.9 percent per year forever. The project requires an initial investment of $1,490,000. Required: (a) If Yurdone requires a return of 15 percent on such undertakings, what is the NPV of the project? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) NPV $ 600440.06 (b) Should the cemetery business be started? (c) The company is somewhat unsure about the assumption of a growth rate of 5.9 percent its cash flows. At what constant growth rate would the company just break even if it still required a return of 15 percent on its investment? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Explanation / Answer

Answer:

Answer A. Here the cash inflows of the project go on forever, which is a perpetuity. unlike ordinary perpetuity cash flows, the cash flows here grow at a constatnt rate forever, Which is growing perpetuity. Formula for valuing a stock with constant growth in dividends. This formula is actually the formula for a growing perpetuity. this formula is going to use here. The PV of the future cash flows for the project is:

PV of cash inflows = C 1 / ( R - g )

PV of cash inflows = $ 126,000 / ( .15 - 0.059 )

                          = $ 126,000 / 0.091 = $ 1,384,615

NPV is the PV of the outflows minus by the PV of the inflows, so the NPV is :

NPV of the project = - $ 1,490,000 + $ 1,384,615 = - $ 105,385

Anser is B. The NPV is negative, so we would reject the project.

Answer C.

Here we need to know the minimum growth rate in cash flows necessary to accept the project. The minimum growth rate is the growth rate at which we would have a Zero NPV.The equation for a Zero NPV, using the equation for the PV of a growing perpetuity is :

0 = - $ 1,490,000 + $ 126,000 / ( .15 - g)

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.