Question

You are thinking of making an investment in a new plant. The plant will generate revenues of $1 million per year for as long as you maintain it. You expect that the maintenance cost will start at $50,000 per year and will increase 5% per year thereafter. Assume that all revenue and maintenance costs occur at the end of the year. You intend to run the plant as long as it continues to make a positive cash flow (as long as the cash generated by the plant exceeds the maintenance costs). The plant can be built and become operational immediately. If the plant costs $10 million to build, and the interest rate is 6% per year, should you invest in the plant?

Answer 1

Answer:

The project's NPV is $3,995,074 and the IRR is 9%, so you should invest in the plant.

Explanation:

total investment $10 million

interest rate 6%

yearly revenues $1 million

maintenance cost per year:

$50,000

then increase by 5% during the following years

I used an excel spreadsheet to help me find out how many years the plant would operate. The plant should continue to operate for 62 years. In the same excel spreadsheet I calculated the net cash flow per year and the NPV of the project using a 6% discount rate.

The project's NPV is $3,995,074 and the IRR is 9%, so you should invest in the plant.