Question

We have the opportunity to building a new manufacturing facility which will reduce our annual cost of production for 50 million pounds of fertilizer from $1.00/lb. to $.70/lb. The life of the new plant will be 20 years. The engineering firm we have hired estimates the cost to build the plant at $80 million, all to be spent in the current year. The contract with the plant construction company limits the maximum cost to the engineering firm estimate plus 10%. NOTE: Answer 1 through 3 with the number in $ millions to two decimal places and number 4 as an annual percentage.

1. What are our expected annual savings if we build the plant?

2. If we own the building site, and its market value is $8 million, what is the NPV of the investment if the engineering estimate is correct, and the cost of capital is 12% per annum?

3. What is the NPV of the given assumptions in b., but now the plant costs the maximum plant construction contract?

4. What is the IRR of the project if the engineering estimate is correct?

Answer 1

Ans Annual Savings production so to new facility million pounds $1 $ 0.70 $0.30 Ilbs 1 Expected annual savings = 50 million xo.30 $ 15 million - 2 If we own incurred. the building land lost will not be cost 9 Manufacturing it engineexing estimate is correct + $ 80 million $ 88 million 10% of $ 80 million Present value of $1 PVAF (12%, 20) 7.4694 annuity factor @ 12% for 20 years NPV of Investment : Annual Saving x PVAF (12%, 2o) – Initial Investment - 18 x 7.4694 $112.04m- $ 88m $ 24.04 million

Page 3 Plant construction cost $ 80 million NPV of Investment = Annual Saving x PVA F (12%, 20)- Initial Investment 15× 7.4694 -Bo $112.041 m - $ 80 m $ 32.04 million IRR of project if engineering estimate is correct trial & error using method :- Present value $ 1 annuity factor @ 20% for PVAF (20% 20 4.0596 20 years + NPV of Investment = 15x4.8696 ( $14.96) m NPu of Investment at 12% $24.04 m Using Interpolation : IRR 12% + 24.04 24.04 +14.96 - * (2012) = 12 % + 4.93% 16.93% IRR