Question

Your company wants to build a new plant in China to increase its capacity for producing a new polymer that is being used widely in consumer goods there. To build the plant, the company would need to pay $175,000,000 now, $150,000,000 at the beginning of next year (i.e. or you can think of it as the end of the first year, whichever you like), and $125,000,000 at the end of the second year to have the plant built. It will be ready to begin operations on the first day of the third year after construction starts (i.e. at end of the second year of construction). Each year it operates, the company will need to take charges at the beginning of the year of $25,000,000 for raw materials, utilities, and labor charges to make product for that year. The company can take sales revenues of $100,000,000 at the end of each year of production year of operation. Assume that the plant will have 20 years of operation and production (i.e. you will have 20 times to pay the production expenses and 20 times you will take sales revenues). So it looks like your company would spend a total of $450M and earn a total net profit over the 20 year life of the plant of $1,500M which sounds very attractive. Assume that your company demands an equivalent annual effective interest rate of 12% on its investments. Answer the following questions:

1. DrawaCashFlowDiagramforthissituation.

2. Using a Present Value Cash Flow Diagram and a Net Present Value

   analysis, should the company build the plant? Justify your answer with a brief explanation based on your NPV analysis. Show what the non‐ discounted and discounted payback period is for this case.

3. A risk analysis person at your company does ananalysis of long term market conditions for the product and recommends that your company require a 15% investor’s rate of return (IRR) which means that you can evaluate this using an effective interest rate of 15% on the investment when calculating the discount factors. Should your company build the plant in this case? Be sure to justify your answer based on both NPV and discounted payback period.

Answer 1

a)

b) Yes, the company should build their plant in China as they have positive NPV

c) Company should not build their plant in China as NPV is negative Value and Disouned Paybac cant be calculated because on the basis of it, the company is not recovering what they've invested.