Question

A company is considering an investment to build a new plant. It would take 2 years to construct the plant. The following investments would be made to build the plant:
- $1.5 million for the land, in year 0
- $4 million to the building contractor at the end of year 1
- $6 million to the building contractor at the end of year 2
The equipment would be purchased and installed in year 2, at a cost of $13 million, to be paid at the end of year 2.

The plant would begin production at the beginning of year 3.

Plant revenues are estimated to be as follows:

Year	3	4	5	6	7	8
Revenue ($Mil)	6	8	13	18	14	8

The company uses a discount rate of 15%.

a) Determine the equivalent value of the project at the end of year 2 (start of production). Show your cash flow diagram and chosen approach for the calculation.
b) To assess risk, at what fraction of the proposed revenues would the project still be attractive, based on the equivalent value calculated earlier?

Answer 1

Cash flow discounting :- (all figures are in million $)

Year	Outflow	Inflow	DR	D Inflow	D outflow
0	1.15			1.15
1	4.00		0.87	3.48
2	19.00		0.76	14.37
3		6.00	0.66		3.95
4		8.00	0.57		4.57
5		13.00	0.50		6.46
6		18.00	0.43		7.78
7		14.00	0.38		5.26
8		8.00	0.33		2.62
				18.99	30.64

a. At end of y2, Equivalent value i.e. at current valuation would be $19M.Discounting of all cash outflow till 2nd year done to find. I had applied Discounted Cash flow approach.

b. Project would be attractive if it earns more than $18.99M after discounting.From 6th year the project will start earning more than cost.