You are considering opening a new plant. The plant will cost $97.9 million up front and...

You are considering opening a new plant. The plant will cost $97.9 million up front and will take one year to build. After that it is expected to produce profits of $30.4 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 7.8%.

Should you make the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.

Solutions

Expert Solution

Cost of Plant = $ 97.9 M

Cash in flows upto perpetuity = $ 30.4 M

PV of cash inflows = 30.4 M/ Opportunity cost = 30.4 / 0.078 = $ 389.74 M

NPV of cash flows = 389.74 - 97.9 M = $ 291.84 M

As NPV > 0, this investment had to be made.

For NPV to be zero, the discount rate at which NPV is zero using excel is

IRR of the cash flows is 31.05%. The maximum deviation permissible in discount rate = (31.05% - 7.8%) = 23.25%

Formulae

Formulae as above...

jeff jeffy answered 1 year ago

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