The Aspen Industrial Company is expanding their production to a new geographic a

Question

The Aspen Industrial Company is expanding their production to a new geographic area. The initial outlay including working capital adjustments for the project is $10,000,000 and the year 1 cash flow is expected to be a negative $2,200,000. The year 2 cash flow is expected to be $1,200,000. The cash flow is expected to grow by approximately 8% for year 3 and a constant 4% per year beyond that. As the company has no intention of ending the project, they are calculating the terminal value as an ongoing concern (perpetuity). What is the NPV of the project if the required rate of return is 14% and should it be accepted?

Explanation / Answer

Forecast the cash flows given the information and growth rates

Terminal Value in year 3 = CF4 / (r - g) = 1,347,840 / (14% - 4%) = 13,478,400

NPV = -10,000,000 + (-2,200,000) / (1 + 14%) + 1,200,000 / (1 + 14%)^2 + (1,296,000 + 13,478,400) / (1 + 14%)^3

= -$1,034,164.36

As NPV < 0, we should not accept the project.

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