You are considering opening a new plant. The plant will cost
$100.6
million up front and will take one year to build. After that it is expected to produce profits of
$30.1
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
7.2%.
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.
The NPV of the project will be
$289.4
million. (Round to one decimal place.)You
should
make the investment. The IRR is
____%.
(Round to two decimal places.)
Answer 1:
The plant will cost $100.6 million up front and will take one year to build. After that it is expected to produce profits of $30.1 million at the end of every year of production
Year 0: Investment of $100.6
Year 2 onwards perpetual cash flows of $30.1 million.
Hence:
Value of project at the end of year 1 = Perpetual cash flow each year from year 2 / Cost of capital
= $30.1 / 7.2% = $418.06 million
Hence:
NPV = $418.06 /( 1+ 7.20%) - $100.6
= $289.3772 million
NPV = $289.4 million
Answer 2:
Yes, you should make investment. The NPV of investment is positive at $289.4 million.
Answer 3:
IRR = 315.56%
Workings:
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