You are considering opening a new plant. The plant will cost $104.4 million up f

Question

You are considering opening a new plant. The plant will cost $104.4 million up front and will take one year to build. After that it is expected to produce profits of $28.5 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 7.8%. Should you make the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.

Explanation / Answer

Solution-

Present value of outflow = 104.4

and present value of inflows = 28.5 * 1.078^-1 + 28.5 * 1.078^-2 + 28.5 * 1.078^-3 + 28.5 * 1.078^-4 .........forever

= 28.5* ( 1.078^-1 + 1.078^-2 + 1.078^-3 + ..... )

= 28.5* 1.078^-1 / ( 1- 1.078^-1) [ infinire GP formula]

= 365.385

Net present value = 365.385 - 104.4

= 260.985

IRR is the rate at which NPV is zero, this is equal to 27.3%

because NPV is zero at 27.3%

So maximum deviation allowable = 27.3 - 7.8

=19.5%

Answer

TY!

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.