Question

The Rodriguez Company is considering an average-risk investment in a mineral water spring project that has a cost of $160,000. The project will produce 750 cases of mineral water per year indefinitely. The current sales price is $145 per case, and the current cost per case is $110. The firm is taxed at a rate of 36%. Both prices and costs are expected to rise at a rate of 6% per year. The firm uses only equity, and it has a cost of capital of 16%. Assume that cash flows consist only of after-tax profits, because the spring has an indefinite life and will not be depreciated.

a. What is the NPV of the project? Do not round intermediate steps. Round your answer to the nearest hundred dollars. (Hint: The project is a growing perpetuity, so you must use the constant growth formula to find its NPV.)

Answer 1

Sales = Number of cases 750 * Sales price / case $145 = $108,750

Costs = Number of cases 750 * Cost / case $110 = $82,500

Gross Margin = Sales $108,750 - Costs $82,500 = $26,250

Net Cash Flow = Gross Margin $26,250 * (1- Tax rate 36%) = $16,800

Growth rate = 6%

Cost of capital = 16%

Real cost of capital = Cost of capital (1+16%) / (1+Inflation 6%) = 9.434%

Value of project = Net Cash Flow $16800 / Real cost of capital 9.434% = $178,080

NPV = Value of project $178,080 - Cost of project $160,000 = $18080