A factory costs $1,000,000 to build. You determine that it will produce cash for

Question

A factory costs $1,000,000 to build. You determine that it will produce cash for 10 years with an inflow of $190,000 a year for the first five years and an inflow of $160,000 a year for last five years. Suppose the interest rate is 12 percent. a) What is the factory worth today? Should you build the factory? b) What will the factory be worth at the end of five years (i.e. five years from now)? (HINT: the price of an asset at a specific point in time is equivalent to the present value of the cash flows that the buyer is expected to receive once she purchases the asset). After five years, you are offered $600,000 to sell the factory. Should you sell it?

Show all formulas you use.

Explanation / Answer

a) Factory is of $1,012,178.97 . The factory shoulda be build.

b) The worth of factory after five years will be $576,764.19.

It should be sold for $600,000 as the selling price will be more than the worth of the factory.

Year Cash Flow($) PV@12% Balance 0 -10,00,000.00 -10,00,000.00 -10,00,000.00 1       1,90,000.00       1,69,642.86     -8,30,357.14 2       1,90,000.00       1,51,466.84     -6,78,890.31 3       1,90,000.00       1,35,238.25     -5,43,652.06 4       1,90,000.00       1,20,748.43     -4,22,903.62 5       1,90,000.00       1,07,811.10     -3,15,092.52 6       1,60,000.00          81,060.98     -2,34,031.54 7       1,60,000.00          72,375.87     -1,61,655.67 8       1,60,000.00          64,621.32         -97,034.35 9       1,60,000.00          57,697.60         -39,336.75 10       1,60,000.00          51,515.72          12,178.97

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