Question

An investor is interested in purchasing a company and wants you to determine the maximum value of the company today considering the opportunity cost of capital is 20%. The company assets are in two areas. First, an existing production operation was developed by the company over the past two years for equipment and development costs of $100,000 two years ago, $200,000 one year ago, and cost and revenues that canceled each other during the past year. It is projected that revenue minus operating expense net profits will be $120,000 per year at the end of each of the next 12 years when production is expected to terminate with a zero salvage value. The second company asset is a mineral property that is projected to be developed for a $350,000 future cost one year from now with expected future profits of $150,000 per year starting two years from now and terminating 10 years from now with a zero salvage value. Use NPV analysis to determine the value of the company on a before-tax basis. Are there any sunk costs in this problem?

USE OF EXCELL SHEET IS ENCOURAGED FOR THIS PROBLEM

Answer 1

Yes there are sunk cost in the Question. Sunk is the irrelevant cost because the cost has already been incurred and will not change whether project accpt or reject.

So Equipment and development cost $100000 two year ago and $200000 one yar ago are the Sunk Cost.

Belwo is the NPV calculation in excel Sheet As per requirement:

Year	Project 1 Cash Flows	Project 2 Cash Flows	Total Cash Flows	PV factor @ 20%	Present Value
0	0.00	0.00	0.00	1.0000	0.0000
1	120000.00	-350000.00	-230000.00	0.8333	-191666.6667
2	120000.00	150000.00	270000.00	0.6944	187500.0000
3	120000.00	150000.00	270000.00	0.5787	156250.0000
4	120000.00	150000.00	270000.00	0.4823	130208.3333
5	120000.00	150000.00	270000.00	0.4019	108506.9444
6	120000.00	150000.00	270000.00	0.3349	90422.4537
7	120000.00	150000.00	270000.00	0.2791	75352.0448
8	120000.00	150000.00	270000.00	0.2326	62793.3706
9	120000.00	150000.00	270000.00	0.1938	52327.8089
10	120000.00	150000.00	270000.00	0.1615	43606.5074
11	120000.00	0.00	120000.00	0.1346	16150.5583
12	120000.00	0.00	120000.00	0.1122	13458.7986
				NPV	744910.1533