You Firm is considering to take over the operation and maintenance of a toll-roa
ID: 3032267 • Letter: Y
Question
You Firm is considering to take over the operation and maintenance of a toll-road in Spain for 6 years (called the concession period). The global business team in the firm suggested a competitive bid price of $25M that is paid to the government of Spain upfront. This money will be borrowed from Morgan Chase at annual interest rate of 5%. The annual income from toll fee collection is $8M for the first three years and $10M for the rest of the concession period. However, the annual maintenance cost is expected to stay at $3M. There will also be a major upgrade at the end of third year which costs $5M. Your manager asks you to perform NPV analysis and present your recommendation in the next meeting with the board. What is the net present value of this project for your firm?Explanation / Answer
Each cash inflow/outflow is discounted back to its present value (PV). Then they are summed. Therefore, NPV is the sum of all terms,
{displaystyle { rac {R_{t}}{(1+i)^{t}}}}Rt /(1+i)t
where
t – the time of the cash flow
i – the discount rate, i.e. the return that could be earned per unit of time on an investment with similar risk
Rt – the net cash flow i.e. cash inflow – cash outflow, at time t.
We are presuming that the annual net inflows are deposited with Morgan Chase to reduce the amount of loan and the interest on loan. It is also presumed that the major upgrade expenditure of $ 5 million is incurred after 3 years i.e. in the 4th year. It is also assumed that the discount rate is 5 %, i.e. the same as the rate of interest charged by Morgan Chase.Then:
The outflow in the initial year is $ 25 million.
4. The inflow in 4th year = $ 10 million; The outflow in the 4th year = 5% of $ 13.178125 million = $ 0.65890625 million plus the maintenance cost of $ 3 million + the upgrade cost of $ 5 million = $ 8.65890625 million. Then, the net inflow in the 4th year is $ 1.34109375 million. This is repaid to Morgan Chase so that the loan amount reduces to $ (13.178125- 1.34109375) million = $ 11.83703125 million Thus, there is no final net inflow/outflow.
5. The inflow in 5th year = $ 10 million; The outflow in the 5th year = 5% of $ 11.83703125 million = $ 0.591851562 million plus the maintenance cost of $ 3 million = $ 3. 591851562 million. Then, the net inflow in the 5th year is $ 6.408148438 million This is repaid to Morgan Chase so that the loan amount reduces to $ (11.83703125-6.408148438)million = $ 5.428882812 million. Thus, there is no final net inflow/outflow.
6. The inflow in 6th year = $ 10 million; The outflow in the 6th year = 5% of $ 5.428882812 million = $ 0. 27144414million plus the maintenance cost of $ 3 million = $ 3.27144414 million. Then, the net inflow in the 6th year is $ 6.728555859 million . Out of this amount, a sum of $ 5.428882812 million is repaid to Morgan Chase towards the entire outstanding loan amount leaving a net inflow of $ 1.299673047 million.
From the above, it is clear that , after repaying the loan amount, there is no net inflow/outflow for the first 5 years. In the 6th year, there is a net inflow of $ 1.299673047 million. The NPV of this amount is $ (1.299673047)/(1.05)6 million = $ (1.299673047)/ 1.3400956641 = $ 0.969836021million = $ 969836.02 ( on rounding off to the nearest cent). Thus, after repaying all the cost and the entire loan, the project starts generating surpluses from the 6th year. The NPV of the surplus in the 6th year is $ 969836.02
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