The Yurdone Corporation wants to set up a private cemetery business. According t

Question

The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is "looking up". As a result, the cemetery project will provide a net cash inflow of $93,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 5 percent per year forever. The project requires an initial investment of $1,460,000. a-1 What is the NPV for the project if Yurdone's required return is 10 percent? b.The company is somewhat unsure about the assumption of a growth rate of 5 percent in its cash flows. At what constant growth rate would the company just break even if it still required a return of 10 percent on investment?

Explanation / Answer

Terminal value at year 1= 93,000 (1+ 0.05)/(0.1- 0.05)

                                  = 93,000* 1.05 / 0.05

                                  = 1,953,000

Total cash flow = 1,953,000 + 93,000 = $2,046,000

Present value of cash flow = PVF@10%,1 *CF

                            = 0.9091 * $2,046,000 = $ 1,860,000

NPV = 1860,000 - 1460,000 = $ 4000,000

Business should be started as NPV is positive

2)

At breakeven NPV =0,

so Present value of cash flow =Initial investment = 1460,000

Present value =(PVF@12%,1*CF) +(PVF@12%,1*Terminal value)

1460,000 = (0.9091 * 93,000) +(0.9091 *TV)

1460,000 = 84,545.45 = 0.9091 TV

   TV =( 1460,000 - 84,545.45) / 0.9091

      = 1,375,454.55 / 0.9091

         = $1,512,984.88

Terminal value = CF1(1+g)/(Rs-g)

$1,512,984.88 = 93,000(1+g) /(0.1-g)

1,512,984.88 /93000 = (1+g)/ (0.1-g)

    16.2687 (0.1 - g) = 1+g

     1.62687 - 16.2687g = 1+g

      1.62687 - 1 = 16.2687g +g

       0.62687 = 16.2687g

      g = 0.62687 /16.2687

        = 0.0385 or 3.85% .

At growth = 3.85% ,company will have NPV =0

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