Question

You are considering opening a new plant. The plant will cost $96 million upfront. After that, it is expected to produce constant profits at the end of every year (the first profits arrive at t=1). The cash flows are expected to last forever. The discount rate is 7%.

At what profits amount would you breakeven in the plant investment? [15 marks]

Answer 1

Cash flows are expected to last forever.

Upfront cost of project = $96,000,000

Discount rate = 7% or 0.07

At cash flows, where cost of investment is equal to present value of investment, is breakeven profits.

Value of investment = Cost of investment

Value of investment formula = Cash flows/discount rate

So, cash flows/ 0.07 = 96,000,000

Breakeven cash flows formula = Cost of investment * Discount rate

= 96,000,000 * 0.07

=$6,720,000

So, at $6,720,000 profits, plant investment would breakeven.

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