You have an opportunity to buy the Newton Falls Paper mill for $15 million. Curr

Question

You have an opportunity to buy the Newton Falls Paper mill for $15 million.  Currently the mill sells standard paper reams and revenues total $5 million per year with fixed costs of $2 million and variable costs of 40% of revenue.  

1.       the intrest rate is 11.64%

1.       If you paid the $15 million and operated the mill as it is now, meaning you earned the $5 million per year in revenues what would be your NPV?  If negative what would you have to pay to get a 0 NPV?          I'm stuck on how to find the npv with the perpetuity. i thought it would be (1 million/ 11.64%)-15 million but its not. please help. thanks.

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Explanation / Answer

Variable costs = 40%*5 million = 2 million

Profit before tax = 5 million - 2 million (variable cost) - 2 million (fixed cost) = 1 million

Net income = profit before tax * (1-tax rate) = 1*(1-35%) = 0.65 million

So NPV = 0.65/11.64% - 15 = -9.42 million

To get a zero NPV, we should pay 15 million - 9.42 million = 5.58 million

Hope this helped ! Let me know in case of any queries.

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