MINI CASE: Daniels New Frontiers Corporation and the Municipal Government Project

Daniels New Frontiers Corporation $($DNFC $)$ is considering a contract for a $33-$year project from a $($government$)$ municipality. The project would be $$self$-$standing$$ meaning that DNFC would be responsible for the project's costs of development, construction, and the expenses of running the operation. Still, the company would also receive all project revenues. From the municipality's vantage point, it hopes the project will have a positive economic impact on the town by increasing jobs and wages and perhaps increasing the town$$s population growth.

The municipality has offered detailed financial information. As the most recently hired college graduate at DNFC$,$ and because of your degree in finance, your supervisor has asked you to evaluate the project and present your findings to the company$$s project evaluation committee. This is your first major assignment, and your reputation depends on the quality of your analysis and a good presentation.

The development and construction of the project will take $3$ years, and the project will operate for $30$ years. The riskless rate is $5\%$; the rate of return on the market portfolio is $10\%,$ and the project$$s beta is $1\mathrm{.}2.$ DCC has no debt. DNFC expects to spend $$250,000$ for land one year after the contract is awarded $($t $=1).$ Construction of the building will cost $$2$ million, and the equipment will cost $$3$ million, both of which will be cash outflows at t $=2.$ The life of the building is $30$ years, and it will be depreciated toward a salvage value of $$50,000.$ The equipment has a five$-$year useful life with no salvage value. The equipment will be replaced at five$-$year intervals for $$3$ million upon each replacement. Straight$-$line deprecation will be used $($over years t $=4,$ t $=8,$ etc.$).$ To support operations, DNFC expects to need $$20,000$ in additional cash, to invest $$60,000$ in accounts receivable and $$80,000$ in inventory, and to maintain $$60,000$ in accounts payable. The investment in net working capital occurs at the start of operations $($t $=3).$ The revenues from the project will amount to $$800,000,$ fixed costs will be $$100,000,$ and variable costs will be $$150,000,$ all on an annual basis. At the end of the project, the firm is expected to restore the surrounding area for $$420,000,$ The firm$$s marginal tax rate is $21\%.$ The value of the land is expected to be constant over the project's life, and the building can be sold for $$150,000$ at the end of the project.

What is the minimum amount the municipality would have to pay DNFC when the contract is awarded $($t $=0)$ to make it worthwhile for DNFC to undertake the project?

Hint: Find the project$$s cost of capital and create a by$-$item capital budgeting analysis Excel spreadsheet like Table $10-4($page $258)$ in the EFS textbook$).$ Also, look at the Perma Filter example $($Canvas Modules, Chapter $10$ Additional Resources, and Chapter $10\mathrm{.}3($Parts $1$ & $2)$ videos$)$ to guide you through setting up the spreadsheet. Finally, remember that a project must have AT LEAST an NPV $=0$ so shareholders achieve the desired rate of return and the share price is not negatively impacted.