Question

You company wants to build a new small plant that will cost $90,000,000 to construct. You will

pay the construction engineering firm $45,000,000 today and another $45,000,000 at the end of the first year of construction. The plant will be finished 24 months from the start of construction. Each year of operation, the plant will take charges of $5,000,000 per year at the beginning of the year for raw materials, labor, and maintenance. Each year of operation, the plant will take credits of $20,000,000 in sales revenues at the end of the year. If the company requires a MARR of 15% and the plant is expected to have a life of 15 years of production, answer the following questions:

a. What is the simple Payback Period for this project ignoring the effects of time value of money? b. What is the NPV of this project using the MARR? c. What is the Discounted Payback Period of this project using the MARR? d. What is the IRR for this project?

Answer 1

(since the cost of RM is considered in the year 2 onwards, even though operations start from year 3. That is because the cost is incurred at the start of year, which is very close to the end of the year before. We should also consider depreciation and taxes, however, since they are not mentioned in the question, I am not considering them - actual statements below the answer)

a) Payback period = Capex / Annual average cash inflow from operations = (90 Mn / 15 Mn) = 6 years

b) NPV = -$10.15Mn

c) Discounted Payback period = Since the NPV of the project is negative, it will not payback the initial investment.

d) IRR = 12.45%

in Mn $	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10	Year 11	Year 12	Year 13	Year 14	Year 15	Year 16	Year 17
Capex	-45	-45
RM Cost		-5	-5	-5	-5	-5	-5	-5	-5	-5	-5	-5	-5	-5	-5	-5
Sales			20	20	20	20	20	20	20	20	20	20	20	20	20	20	20
Total	-45	-50	15	15	15	15	15	15	15	15	15	15	15	15	15	15	20