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

Question

You have an opportunity to buy the Newton Falls Paper mill for $15 million.  If you buy the facility your plan is to produce one or more specialty papers where you believe the margins are higher.  You would also like to update and modernize the mill.  To do this you will have to purchase two new paper machines for $1.5 million each and a new computer system for another $1 million.

You expect revenues to be:

$6 million year 1

$8 million year 2

$9 million year 3 and ongoing.

You expect your variable costs to equal 20% or revenues and your fixed costs to equal $4.5 million (depreciation expense is not included in this estimate of fixed costs).

the cost of equity is 11.64%. Assume a tax rate of 35%.

1.       

Should you purchase the mill and implement your plan of producing different paper?  What is the NPV?  

Explanation / Answer

Variable cost=20%*(6+8+9)=4.6 million

Fixed cost=4.5 million

Pv of inflow=5.376 million+ 6.416+6.462=18.254 million

Cash inflow=18.254-4.6-4.5=9.154*(1-0.35)=5.9501 million

cash outflow=15+1.5+1.5+1=19

NpV=-19+5.9501=-13.0499million

as NPV is negative it should not be implemented..

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