Question

Consider a hypothetical economy that has NO tax. ABC Ltd. is considering investing in a 2-year project which is expected to generate the following year-end cash flows: C1 = $110 million, C2 = $115 million. The yearly discount rate for the project is 10%. The initial cost of the project is $200 million.

(f) Now suppose that of the $200m initial expenditure, $50m was used for the purchase of a machine that has an estimated economic life of four years. The machine will be fully depreciated (i.e., zero book value at the end of the machine’s economic life) on a straight-line basis and expected to have a resale value of $35m at the end of the project.

(i) Explain how this will affect the size of the terminal (end-of-project) cash flows.

(ii) How will this affect the NPV and the acceptance/rejection of the project (as compared to part (a))? Show your calculations.

part a NPV = -4.959 million

Answer 1