The company is starting new chemicals production facility with an initial invest
ID: 2796937 • Letter: T
Question
The company is starting new chemicals production facility with an initial investment of $1billion. They don’t expect to generate any cash flow for the first two years. In year 3, cash flow is expected to be $150 million and will increase by 15% every year till year 7 after which time it will decline by 2% until year 9. The company expects no growth in cash flows beyond year 9 and cash flows to continue at year 9 levels into foreseeable future.
Calculate the NPV and the pay-back period of this project.
Thanks so much for your help. Much appreciated.
Explanation / Answer
Forecast cash flows given the information and growth rate.
CF 4 = CF3 x (1 + g) = 150 x (1 + 15%) = 172.50 and so on..
CF8 = CF7 x (1 + g) = 262.35 x (1 - 2%) = 257.10, CF9 = 257.10 x (1 - 2%) = 251.96 = CF10... CFn
In order to calculate NPV, we need discount rate, which is not mentioned.
Payback Period is the no. of years it takes to recove $1 billion
Payback = 6 + (1000 - 150 - 172.50 - 198.38 - 228.13) / 262.35 = 6.96 years.
Year CF 0 -1000.00 1 0 2 0 3 150.00 4 172.50 5 198.38 6 228.13 7 262.35 8 257.10 9 251.96 10 251.96