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 $105,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 5 percent per year forever. The project requires an initial investment of $1,580,000.

What is the NPV for the project if Yurdone's required return is 10 percent? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

If Yurdone requires a return of 10 percent on such undertakings, should the firm accept or reject the project?

The company is somewhat unsure about the assumption of a 5 percent growth rate in its cash flows. At what constant growth rate would the company just break even if it still required a return of 10 percent on investment? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

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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 $105,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 5 percent per year forever. The project requires an initial investment of $1,580,000.

Explanation / Answer

Answer:a-1 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 constant rate forever, which is a growing perpetuity. If you remember back to the chapter on stock valuation, we presented a formula for valuing a stock with constant growth in dividends. This Formula is actually the formula for a growing perpetuity, so we can use it here.

The PV of the future cash flows from the project is:

PV of cash inflows = C 1 /( R – g )

PV of cash inflows = $105,000/(.10 – .05) = $2100000

NPV is the PV of the outflows minus the PV of the inflows,

so the NPV is:

NPV of the project = –$1,580,000 + 2100000 = $520000

Answer:a-2 Yes, the firm should accept the project because NPV is positive.

Answer:b Here we want 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 = –$1,580,000 + $105,000/(.10– g )

Solving for g ,

we get: g = 3.35%

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