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$ 98.3$98.3 million up front and will take one year to build. After that it is e

ID: 2795429 • Letter: #

Question

$ 98.3$98.3

million up front and will take one year to build. After that it is expected to produce profits of

$ 29.1$29.1

million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is

8.3 %8.3%.

Should you make the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.

You are considering opening a new plant. The plant will cost $98.3 million up front and will take one year to build. After that it is expected to produce profits of $29.1 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 8.3%. Should you make he investment? Calculate the RR and use i o determine he maximum deviation a ova in the cost o ca e mate leave the eClSIO unchanged The NPV of the project will be $million. (Round to one decimal place.) You The IRR is %. (Round to two decimal places.) The maximum deviation allowable in the cost of capital estimate is %. (Round to two decimal places.) I make the investment. (Select from the drop-down menu.)

Explanation / Answer

Present value of Cash outflow 98.3 Cash inflow every year for infinity 29.1 PV of cash inflow for infinity= Cash inflow every year/cost of capital Present value of Cash inflow =29.1/8.3% 350.60 Net Present value= PV of Cash inflow - PV of Cash outflow Net Present value= 350.60-98.30 Net Present value= 252.3 Calculation of IRR At IRR, present value of cash inflow will be equal to cash outflow As we have seen earlier, PV of cash inflow for infinity= Cash inflow every year/cost of capital @ 25% Present value of Cash inflow =29.1/25% 116.4 NPV =116.4-98.3         18.10 @ 30% Present value of Cash inflow =29.1/30%            97.00 NPV =97.0-98.3         (1.30) IRR =Lower rate + Difference in rates*(NPV at lower rate)/(Lower rate NPV-Higher rate NPV) IRR =25%+5%*(18.10/(18.10+1.30)) 29.665%

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