Question

The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is "looking up." As a result, the cemetery project will provide a net cash inflow of $87,900 for the firm during the first year, and the cash flows are projected to grow at a rate of 5 percent per year forever. The project requires an initial investment of $1,400,000.
What is the NPV for the project if Yurdone's required return is 10 percent? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
If Yurdone requires a return of 10 percent on such undertakings, should the firm accept or reject the project?
The company is somewhat unsure about the assumption of a 5 percent growth rate in its cash flows. At what constant growth rate would the company just break even if it still required a return of 10 percent on investment? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Answer:

What is the NPV for the project if Yurdone's required return is 10 percent?

• $358,000

If Yurdone requires a return of 10 percent on such undertakings, should the firm accept or reject the project?

• Yes, because the project's NPV is positive, which means that its IRR is higher than the required rate of return.

At what constant growth rate would the company just break even if it still required a return of 10 percent on investment?

• 3.72%

Explanation:

initial investment = $1,400,000

net cash inflow₁ = $87,900

perpetual growth rate = 5%

required rate of return = 10%

project's current intrinsic value = $87,900 / (10% - 5%) = $1,758,000

project's NPV = $1,758,000 - $1,400,000 = $358,000

$1,400,000 = $87,900 / (10% - g)

$1,400,000(10% - g) = $87,900

$140,000 - $1,400,000g = $87,900

$140,000 - $87,900 = $1,400,000g

$52,100 = $1,400,000g

g = $52,100 / $1,400,000 = 3.72%