On January 1, Year 1, assume that Levi Strauss opened a new textile plant to produce synthetic fabrics. The plant is on leased land; 20 years remain on the nonrenewable lease.

The cost of the plant was $20 million. Net cash flow to be derived from the project is estimated to be $3,000,000 per year. The company does not normally invest in such projects unless the anticipated yield is at least 12 percent.

On December 31, Year 1, the company finds cash flows from the plant to be

$2,800,000 for the year. On the same day, farm experts predict cotton production will be unusually low for the next two years, Levi Strauss estimates the resulting increase in demand for synthetic fabrics will boost cash flows to $3,500,000 for each of the next two years. Estimates for subsequent years remain unchanged. Ignore tax considerations.

a. Calculate the present value of the future expected cash flows from the plant when it opened.

b. What is the present value of the plant on January 1, Year 2, immediately after the reestimation of future income?

c. On January 2, Year 2, the day following the cotton production news release, a competitor announces plans to build a synthetic fabrics plant, to open in three years. Levi Strauss keeps its Year 2 to Year 4 estimates but reduces the estimated annual cash flows for subsequent years to $2,000,000. What is the value of Levi Strauss's present plant on January 1 , Year 2, after the new projections'?

d. On January 2, Year 2, an investor contacts Levi Strauss about purchasing a 20 percent share of the plant. If the investor expects to earn at least a 12 percent annual return on the investment, what is the maximum amount that the investor can pay?

Assume that the investor and Levi Strauss both know all relevant information and use the same estimates of annual cash flows.

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