Question

You are considering opening a new plant. The plant will cost $99.5 million upfront and will take one year to build. After that, it is expected to produce profits of $29.2 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 8.1%. Should you make the investment? Calculate the IRR. Does the IRR rule agree with the NPV rule? Years N 2 Forever 3 ST 29.2 29.2 Cash Flow ($ million) -99.5 29.2 N Calculate the NPV of this investment opportunity if your cost of capital is 8.1%. The NPV of this investment opportunity is $ million. (Round to one decimal place.) Should you make the investment? (Select the best choice below. O A. No, because the NPV is not greater than the initial costs. OB. Yes, because the project will generate cash flows forever. OC. Yes, because the NPV is positive OD. No, because the NPV is less than zero. Calculate the IRR. The IRR of the project is %. (Round to two decimal places.)

Answer 1

1. NPV of Invested Opportunity =Cash Flows/(Cost of Capital*(1+Cost of Capital))-Investment =29.2/(8.1%*(1+8.1%))-99.5=233.98

Option b . This project must be selected because NPV is positive(This is the NPV rule for selection of Projects)

2.As per irr Rule
Investment =Cash Flow/(IRR*(1+IRR)
IRR+IRR^2 =29.2/99.5
By solving for quadratic equation
IRR =23.72%
Option a is correct option Since IRR is greater than cost of capital it should be accepted