Your company is considering the following capital investment in additional plant

Question

Your company is considering the following capital investment in additional plant and equipment. The additional plant and equipment will generate revenues of $1,200,000 per year for as long as you maintain it, increasing by $40,000 each year after the first year. The maintenance cost will start at $350,000 per year and increase by $20,000 each year, after the first year. The plant can be built and will become operational immediately. At the end of eight years, the plant and equipment will be obsolete. Assume that all revenue and maintenance costs occur at the end of the year. The plant and equipment will require an investment of $4,800,000. The discount rate is 9.5 %. Ignore taxation. Question 2.1: Calculate the net present value of the capital investment. (10 Marks) Question 2.2: Calculate the payback period of the capital investment

Explanation / Answer

NPV: 0 1 2 3 4 5 6 7 8 Initial investment -4800000 Incremental revenues 1200000 1240000 1280000 1320000 1360000 1400000 1440000 1480000 Incremental maintenance cost 350000 370000 390000 410000 430000 450000 470000 490000 Incremental operating cash flow 850000 870000 890000 910000 930000 950000 970000 990000 Project cash flows -4800000 850000 870000 890000 910000 930000 950000 970000 990000 PVIF at 9.5% 1 0.91324 0.83401 0.76165 0.69557 0.63523 0.58012 0.52979 0.48382 PV at 9.5% -4800000 776256 725590 677872 632973 590762 551111 513893 478985 NPV 147441 CALCULATION OF PAYBACK: Cumulative cash flows -4800000 -3950000 -3080000 -2190000 -1280000 -350000 600000 1570000 2560000 Payback period = 5+350000/950000 = 5.37 years

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