Question

A manufacturing company is thinking about building a new factory. The factory, if built, will yield the company $300 million in 7 years, and it would cost $220 million today to build. The company will decide to build the factory if the interest rate is__________

Answer 1

Answer:

lower than 4.53%

Explanation:

To determine whether the project is viable, we will use the Internal Rate of Return (IRR). This is the rate at which the Net Present Value (NPV) becomes Nil. In other words, the point at which the discounted net cash outflows are equal to the discounted net cash inflows

In this question, there is one outflow of cash worth $220 million at the start of the project (t=0) and one inflow of $300 million in 7 years.

To calculate IRR, we will use the following formula:.

220 = [300 / ((1+r)^7)]

Solving for r, we find that the interest rate is 4.53%.

Given the cash flows, the project should be accepted at all rates below 4.53% as it will create value for the company.