Question

Mustang Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $277,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $112,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 3 percent. Production costs at the end of the first year will be $37,000, in nominal terms, and they are expected to increase at 4 percent per year. The real discount rate is 6 percent. The corporate tax rate is 34 percent. what is the NPV of the project? Do not round intermediate calculations and round your answer to 2 decimal places.

Answer 1

The nominal required rate of return is:

(1 + R) = (1 + r) × (1 + h)

(1 + R) = (1 + .06) × (1 + .03)

(1 + R) = 1.0918

R = 1.0918 - 1 = 0.0918, or 9.18%

NPV = PV of Cash Inflows - PV of Cash Outflows

= [$51,617/1.0918¹] + [$52,256/1.0918²] + [$52,910/1.0918³] + [$53,577/1.0918⁴] + [$54,260/1.0918⁵] + [$54,957/1.0918⁶] +[$55,669/1.0918⁷] - $277,000

= $47,276.97 + $43,837.92 + $40,654.49 + $37,705.62 + $34,975.53 + $32,446.25 + $30,103.14 - $277,000

= -$9,159.15