NPV of Growing Perpetuity The Yurdead Corporation wants to set up a private crem

Question

NPV of Growing Perpetuity The Yurdead Corporation wants to set up a private cremation business. According to the CFO, Barry M. Deep, people are dying to take advantage of their services. He has projected that the company will make $52,000 in the first year, and cash flows are expected to grow at 5% per year thereafter. The project requires an initial investment of $900,000. Barry has assessed the company's cost of capital to be 11%. Should he undertake the opportunity? Barry is unsure of the growth rate and wants to do a bit of sensitivity analysis around this rate. At the 11% rate of return, what is the breakeven growth rate for this project?

Explanation / Answer

NPV at growth rate 5:

= $52,000/(11%-5%)-$900,000

= -$33,333

It should not undertake project.

Breakeven growth rate:

= Rate of return-Annual cash flows 1/Investment

= 11%-$52,000/$900,000

= 11%-5.78%

= 5.22%

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