Question

NET PRESENT VALUE EXERCISE

You are investing in a container ship to move your products across the Atlantic Ocean.   Building the ship will cost $2.5 billion, and after operating costs it is expected to bring in $350 million per year for the next 10 years, after which it will have no salvage value. What is the NPV of this project? Assume k = 14%

(Be sure to show your work)

YEAR	NET CASHFLOW
0	($2.5 B)
1	$350 M
2	$350 M
3	$350 M
4	$350 M
5	$350 M
6	$350 M
7	$350 M
8	$350 M
9	$350 M
10	$350 M

What do your results mean? Should you proceed with this project? How would country risk change your considerations?

** Please Answer, Time Sensitive**

Answer 1

Answer:

Initial Investment:

Initial Investment = $2.5 Billion = $2,500 million

Annual Operating Cash flow:

Annual operating income (amount after operating costs) per year for next 10 years = $350 million

Depreciation is an operating expense and hence is assumed that it has been deducted to arrive at operating income. To get annual operating cash flow we have to add it back.

Depreciation = (Cost of ship - Salvage value) /Useful life = (2500 - 0) / 10 = $250 million

Annual operating cash flow = Annual operating income + Depreciation = 350 + 250 = $600 million

PVA Factor:

PV factor for annuity of $1 for 10 years at discount rate of 14% = (1 - 1 / (1 + k) ⁿ) / k = (1 - 1 / (1 +14%) ¹⁰) / 14%

NPV:

NPV = Annual cash flow * PVA factor - Initial Investment

= 600 * (1 - 1 / (1 +14%) ¹⁰ ) / 14% - 2500

= 629.669387776 million

NPV (in nearest cents) = $629,669,387.78

NPV (in millions with two decimal points) = $629.67 millions

The results mean that the project should be accepted. You should proceed with the project since the NPV is positive at $629.67 million.

Country risks could be political risk, economic risks, exchange rate risk, Industry risks, Competitiveness risks etc.

Country risk may change considerations and:

1. We have to factor in political risk, economic risks, exchange rate risk, Industry risks, Competitiveness risks in annual cash flows and initial investment

2. We have to factor in such risks in project duration

3. We can also factor in such risks in discount rate.

We have to reevaluate the project with revised initial investment, annual cash flows, project duration and discount rate.