Middlefield Motors is considering project X, which would involve opening a new d

Question

Middlefield Motors is considering project X, which would involve opening a new dealership that would sell trucks only. The project would require an initial investment of 10,060 dollars today and is expected to produce annual cash flows of 900 dollars each year forever with the first annual cash flow expected in 1 year. What is the NPV of project X, based on the information in this paragraph and the following table and applying the pure play approach to determining a project’s cost of capital?

Firm Line of business WACC Middlefield Motors Sells cars 11.25 percent Toledo Trucks Sells trucks 9.7 percent Vehicle Depot Sells cars, trucks, and vans 5.53 percent

Explanation / Answer

Cost of capital that should be used by Middle field motors is of Toledo trucks since it is in the same business of selling trucks and it is assumed that all other things for both the companies are same

Therefore cost of capital = 9.7%

Annual cash flow of the project forever = $900 per year

PV of cash inflow = 900/0.097 = $9278.3505155

NPV = $9278.3505-$10060 = -$781.6494845 I.e. -$781.6495

Since NPV is negative the project should not be accepted

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