Question

Fajar Factory wants to build a rice processing factory that will take a year to build. $5 million is spent right away and another $5 million is spent next year. The company CEO is expecting that the factory will lose $1 million in its first year of operation and lose another half a million in its second year of operation. with that initial investment, the factory is expected to produce 8000 rice packs per month and sold fo $30 per unit for nest 20 years. meanwhile, the production cost for pack is $20.

If the discount rate is 4% ,what is the net present value of the investment ?

What if discount rate is 2%? Whould your decision different ?

Answer 1

The detailed cashflow, with NPVs (both 4% and 2%) is given below. Explanation follows

The initial 2 years have -5million as investment. The factory then starts operating. The manager has expectations of net losses of 1 million in first year of operations and then another .5m loss in the second year. Post that, the plant will make 8000 rice packs each month with $10 profit per bag (30 price and 20 cost, 30-20=10). This gives us 8000*10*12=96000 profit per year. This will go on for another 18 years (as the total operational years is 20).

The NPV has been calculated with formula =npv(rate,cashflow)+initial investment

It can also be calculated manually by the formula

NPV= Initial investment+Cashflow1/(1+r)+cashflow2/(1+r)²+.....+cashflown/(1+r)ⁿ

Where n is the number of years, r is the interest rate.

We can see that NPV at 4% interest rate is -372841. We cant go ahead.

But at 2%, the NPV becomes 2227942. In this case we can go ahead.