A construction company is evaluating an investment project consisting in developing a new residential building on...

A construction company is evaluating an investment project consisting in developing a new residential building on a plot of land. The cost of the land, to be paid in t=0, is €500K and construction would take 2 years. Construction costs are estimated to be €650K in t=1 and €650K in t=2. The building would then generate an annual cash flow of €250K in perpetuity, starting from t=3. If the cost of capital is 8%, the NPV of this project is closest to:

A. €1,190K B. €1,020K C. €1,466K D. €1,357K

Solutions

Expert Solution

Value of perpetuity in year 2 can be computed using formula for PV of perpetuity as:

PV = C/r

C = Periodic cash flow starting in next year = € 250 K

r = Cost of Capital = 0.08

Value of cash inflow in year 2 = € 250 K/0.08

= € 3,125 K

Total cash flow in year 2 = € 3,125 K - € 650 K = € 2,475 K

Cash outflow in year 0, 1 are € 500 and € 650 respectively

NPV = PV of cash inflows – PV of cash out flows

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 8 % (F)	PV (C x F)
0	-€500 K	1/ (1+0.08)0	1	-€500 K
1	-€650 K	1/ (1+0.08)1	0.925925925925926	-€601.8518519 K
2	€2,475 K	1/ (1+0.08)2	0.857338820301783	€2,121.9135802 K
			NPV	€1,020.0617283 K

NPV of the project is € 1,020.0617283 K or € 1,020 K

Hence option “B. € 1,020 K” is correct answer

jeff jeffy answered 1 year ago

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