You are considering constructing a new plant in a remote wilderness area to proc

Question

You are considering constructing a new plant in a remote wilderness area to process the ore from a planned mining operation. You anticipate that the plant will take a year to build and cost

$ 100

million upfront. Once? built, it will generate cash flows of

$ 16

million at the end of every year over the life of the plant. The plant will be useless

20

years after its completion once the mine runs out of ore. At that point you expect to pay

$ 220$220

million to shut the plant down and restore the area to its pristine state. Using a cost of capital of

13 %

a. What is the NPV of the? project?

b. Is using the IRR rule reliable for this? project? Explain.

c. What are the IRRs of this? project?

Explanation / Answer

The NPV of the project is -$6.712 millions. As the NPV is negative the project should not be accepted.

b. No, the IRR is not reliable for this project as the outflows are not only at the beginning of the year. When the cashflows change sign more than once than the IRR is not the correct way of assessing the project.

c. IRR is the rate at which outflows and inflows are equal. In this case the total outflow is 320 and also the total inflow is 320 (16*20). At the rate of 0% inflows and outflows would be equal. Therefore, IRR is 0%.

Year Amount PV Factor PV 0 -100 1 -100 1 16 0.885 14.16 2 16 0.783 12.53 3 16 0.693 11.088 4 16 0.613 9.81 5 16 0.543 8.69 6 16 0.480 7.68 7 16 0.425 6.8 8 16 0.376 6.02 9 16 0.333 5.33 10 16    0.295 4.72 11 16 0.261 4.18 12 16 0.231 3.7 13 16 0.204 3.26 14 16 0.181 2.9 15 16 0.160 2.56 16 16 0.141 2.26 17 16 0.125 2 18 16 0.111 1.78 19 16 0.098 1.57 20 -204 0.087 -17.75 TOTAL -6.712

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