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To illustrate and further support our strategic financial planning systems we need to show the CFO and management team an example of the application of
To illustrate and further support our strategic financial planning systems we need to show the CFO and management team an example of the application of the previously constructed WACC. The CFO thinks that showing management how we can validate and choose projects based on expected returns developed from the WACC will help reduce the risk of our investors capital thus lowering the required rate of return we would have to provide to those investors. If we lower our expected return we can then do more projects and grow at a faster rate.
He has asked your team to evaluate the following project:
Capital investment: BEB is planning the construction of a new loading ramp for its single mill. The initial cost of the investment is $ followed by an investment of $ years later and another investment of $ years later and finally an investment of $ for environmental cleanup at the end of the project years from now. Efficiencies from the new ramp are expected to reduce costs by $ per year at the end of every year for the life of the plant, which is currently estimated at years savings of $ a year from years These savings can be assumed to be reinvested at a rate of pa What is the NPV of the project if BEB has a required rate of return of What is the MIRR of the project if the investing return rates with the loading ramp used as collateral for a period of years is pa and the term structure of investing return rates for Y years Y is Y pa You should use these investing return rates to discount back to the present the future investments that the loading ramp needs.
Concept Check: We need to adjust cash flows to account for things like inflation, our cost of capital, and opportunity costs. Simply looking at cash flow not adjusted for some of these costs will lead to taking on projects which are not adding to the value of the organization.
Helpful Hint: The first step in conducting an NPV analysis is to include all the relevant cash flows. This includes savings from taxes and any expenses directly related to the venture. We reject any project with a negative NPV
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