Question

You are considering opening a new plant. The plant will cost $ 102.1 million up front and will take one year to build. After that it is expected to produce profits of $ 30.5million 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 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.

The NPV of the project will be    $million.  ​(Round to one decimal​ place.)

You make the investment.  ​(Select from the​ drop-down menu.)

The IRR is ​%. (Round to two decimal​ places.)

The maximum deviation allowable in the cost of capital estimate is ​%.

 

Answer 1

Answer a.

Initial Investment = -$102.1 million
Annual Profit = $30.5 million
Cost of Capital = 8.30%

NPV = Initial Investment + Annual Profit / Cost of Capital
NPV = -$102.1 million + $30.5 million / 0.0830
NPV = -$102.1 million + $367.5 million
NPV = $265.4 million

The NPV of the project will be $265.4 million. Yes, you should make this investment.

Answer b.

Let IRR of the project is i%

NPV = Initial Investment + Annual Profit / Cost of Capital
0 = -$102.1 million + $30.5 million / i
$102.1 million = $30.5 million / i
i = 0.2987 or 29.87%

The IRR is 29.87%

The maximum deviation allowable in the cost of capital estimate is 21.57% (29.87% - 8.30%)