You are helping a manufacturing firm decide whether it should invest in a new pl

Question

You are helping a manufacturing firm decide whether it should invest in a new plant. The initial investment is expected to be $ 50 million, and the plant is expected to generate after-tax cash flows of $ 5 million a year for the next 20 years. There will be an additional investment of $ 20 million needed to upgrade the plant in 10 years. If the discount rate is 10%, Estimate the Net Present Value of the project (7 marks) Should this project be accepted or rejected? Explain your answer? (3 marks) Estimate the Internal Rate of Return for this project. (8 marks)

Explanation / Answer

NPV is the difference between present value of all cash inflow and initial cost of asset or project.

All the future cash flows are discounted using discounting rate or required rate and the sum of all the discounted cash flows will be subtracted with initial cost.

NPV = PV of future cash inflow - initial cost

First we will calculate PV of costs

PV of costs = 52,000,000 + 20,000,000* PVIF (10%, for 10 years)

PV of costs = 52,000,000 + 20,000,000*0.38554

PV of costs = 52000000 + 7710800

PV of costs = 59710800

Now we will calculate PV of cash inflow

PV of inflow = 5000000* PVIFA (10% for 20 years)

PV of inflow = 5000000* 8.513564

PV of inflow = 42567820

Lets put the values in the formula to calculate NPV

NPV =42567820 – 59710800

        = (17142980)

NPV is negative, so the project should be rejected

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