Question
The Melon Company is thinking of building a new plant to put the melon it grows into cans. The plant is expected to last for
The Melon Company is thinking of building a new plant to put the melon it grows into cans. The plant is expected to last for 20 years. Its initial cost is $20 million. This cost can be depreciated over the full 20-year life of the plant using straight-line depreciation. It will require a major renovation which will cost $8 million in real terms after 10 years. This cost of renovation can be depreciated (again using straight-line depreciation) over the remaining 10 years of the plant's life. The land the plant is built on could be rented out for $500,000 a year in nominal terms for twenty years. The salvage value of the plant at the end of the twenty years is $3.5 million in nominal terms. This salvage value is attributed to the original expenditure on the plant for tax purposes. There is no salvage value with regard to the renovation.
The plant will be able to produce 50 million cans of melon a year. The price of a can of melon is currently $0.50. It is expected to grow at a rate of 3% per year in real terms for 6 years and then at 0% in real terms for the remainder of the plant's life. The firm expects to be able to sell all the cans of melon it can produce. The melon the firm puts in the cans is grown in the firm's own orchards. If the melon were not canned they could be sold to supermarkets. The current price they could obtain per melon is $0.1. This price is expected to grow at a rate of 2% in real terms for 5 years and then at 1% in real terms for the next five years and finally at 0% in real terms for the remainder of the plant's life. Each can requires 2.5 melon to fill it. The raw materials for the cans currently cost $0.05 per can. These costs are expected to remain constant in real terms. The labor required to operate the plant costs a total of $5 million dollars a year in real terms. Initially, the total working capital requirement is $10 million and this is expected to remain constant in real terms.
The rate of inflation is expected to be 4% per year for the next four years and 3% per year for the remainder of the plant's life. The firm's total tax rate including local taxes is 38 per cent. The firm expects to make substantial profits on its other operations so that it can offset any losses on the melon canning plant for tax purposes. Its opportunity cost of capital for projects of this type is 14% in nominal terms.
What is the NPV?
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