Question
2. You are starting a company that has the opportunity to invest in a project. The project requires 10 million dollars of an initial capital
2. You are starting a company that has the opportunity to invest in a project. The project requires 10 million dollars of an initial capital investment today to build a factory. The factory will start producing output in one year and will continue until 10 years from now (so it is productive in years 1 through 10). Once you have built the factory, every year it is productive you will have annual costs of 5 million dollars to run it. The factory will generate 50,000 overpriced nance textbook, each of which can be sold for 200 dollars. At the end of year 10, the factory can be sold for a salvage value of 2 million dollars. Your company uses straight-line depreciation to compute the depreciation in each year. The corporate tax rate is 25 %.
(a) In each of years 1 through 10, what are the revenues of the rm? What are its costs?
(b) In years 1 through 10, how much depreciation does the rm have? By how much does this reduce the rms corporate taxes?
(c) What are the rms free cash ows in each year from today (year 0) until the end (year 10)?
(d) Suppose your annual discount rate is 5 %. What is the NPV of building the factory?
(e) Before the rm builds the factory, it has a cash pile of 20 million dollars and owes outstanding debt worth 25 million dollars. What is the value of the rms equity at time 0 if it chooses to build the factory?
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