Question

You are considering opening a new plant. The plant will cost S98.1 million upfront and will take one year to build. After that, it is expected to produce profits of $30.9 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 7.3%. Should you make the investment? Calculate the IRR. Does the IRR rule agree with the NPV rule? Here is the cash flow timeline for this problem Years 4 Forever 30.9 30.9 Cash Flow ($ million)-98.1 Calculate the NPV of this investment opportunity if your cost of capital is 7.3% The NPV of this investment opportunity is $ 296.399 million. (Round to one decimal place.) Should you make the investment? (Select the best choice below.) O A. Yes, because the project will generate cash flows forever 30.9 30.9 B. No, because the NPV is less than zero C. No, because the NPV is not greater than the initial costs D. Yes, because the NPV is positive Calculate the IRR. The IRR of the project is (Round to two decimal places.) Enter vour answer in the answer box and then click Check Answer. parts remaining Clear All Check Answer

Answer 1

Since the investment is perpetual:

Present value of all future cash flows=Cash flow/rate

=$30.9/0.073

=$423.29

This has to be discounted back one year as it is value at end of year 2.

=$423.29/(1+0.073)=$394.49

NPV=-98.10+394.49
=$296.4

Yes, Because NPV is positive

The cash flow time line is such:

Year	Cash Flow
0	-98.1
1	423.29
IRR	331.49%