Based on response to 3-6 Finance questionbelow, provide comments to the response

Question

Based on response to 3-6 Finance questionbelow, provide comments to the response.

3-6. Problem 6, p 77: You run a construction firm. You have just won a contract to build a government officebuilding. Building it will require an investment of $10million to day and $5 million in one year. The governmentwill pay you $20 million in one year upon the building’scompletion. Suppose that the cash flows and their times ofpayment are certain, and the risk-free interest rate is 10%. What is the NPV of the opportunity? How can you firm turnthis NPV into cash today?

Response:

A) Payed Value Today = $10,000,000 + ($5,000,000/1.10) =$10,000,000 + $4,545,454.55 = $14,545,454.55
Received Value Today = $20,000,000/1.10 = $18,181,818.18
NPV = $18,181,818.18 - $14,545,454.55 = $3,636,363.63

B) One year from now, your investments would cost $16mil. Thegovernment is paying you $20mil at this same time. This means that1 year from now, you will have a 4mil profit. If you borrow the$3,636,363.63 now and get cash, your borrowing will cost you 10%interest which is ~$4mil.

Explanation / Answer

The NPV of a project tells us about the feasibility of aninvestment. Go ahead with the projectif it has a positive NPV. Abandon the project if ithas a negative NPV. The NPV of the givenproject is substantially positive. To convert it into cash, goahead with the initial investment.

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