TeleStark is considering building a new manufacturing plant. This plant will cos
ID: 2613438 • Letter: T
Question
TeleStark is considering building a new manufacturing plant. This plant will cost $9 million to build. The new plant will produce cash inflows of $2.05 million per year for the next 7 years. TeleStark already owns the land on which it intends to build the new plant. TeleStark spent $1.3 million to excavate the land and prepare it for development. Rather than building the plant, TeleStark could sell the land today for a net gain of $2 million. If TeleStark’s required return is 9.1%, should it build the plant? How much value does this project create (or destroy) in present value terms?
Explanation / Answer
Total Outflow for the Project:
Cost of Plant = $9 million
Add: Amount spent to excavate the land = $1.3 million
Total Outflow = 10.3 million
Inflow = $2.05 million per Year for 7 Year
Total Inflow = 2.05 x 7 = $14.35 million
Present Value = 14.35 / (1+ 0.091)^7
Present Value of Inflow = $7.80 million
Value destroy in Present Value Terms = 10.3 - 7.80 = $2.50 million
Add: Opportunity cost of land = $2 million
Total value destroy = $4.50 million.
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