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 $91,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 3 percent per year forever. The project requires an initial investment of $1,440,000.
a. What is the NPV for the project if Yurdone's required return is 12 percent?
b. The company is somewhat unsure about the assumption of a 3 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 12 percent on investment?

Answer 1

Answer:

A) NPV= - $428,888.89 B) Company would break Even if g = 5.68%

Explanation:

Hi, we have to bring to present value all the inflows and outflows of cash, this is the formula to use and the math of it.

$NPV=-Invesment+\frac{CashFlowYr1}{(return-growth)}$

$NPV=-1440000+\frac{91000}{(0.12-0.03)} = -428888.89$

The question says that "at what constant growth rate would the company just break even..." and well, a NPV=0 is not precisely break even, actually, it means that the company is obtaining exactly what is asking for any investment, but let´s assume that the question was, what should the growth rate be for the company to accept this project?. So we have to solve the first equation for "g", that is:

$g=\frac{(Invesment*return-CashFlowYr1)}{Invesment} =\frac{(1440000*0.12-91000)}{1440000} =0.0568$

So the constant growth rate has to be at least 5.68% for the company to accept this project (NPV=0)

Best of luck