Question

Weasley’s Exterminators runs a chain pest control service centers. Analysts predict that if the company opens a location in a new city, it will cost $900,000 up front and generate free cash flow as follows: year 1 Free cash flow $60,000 year 2 free cash flow $70,000 year 3 free cash flow $80,000 After year three, the free cash flows will grow forever at a 3% rate. Weasley’s cost of capital is 9%. a. What is the NPV of opening up a new location? b. What is the present value today of all cash flows that a new location will generate from year four and beyond? What percentage of the project’s total cash inflows does that account for? c. What is the NPV if the long-term growth rate in cash flows is 1%? 0%?

Answer 1

Weasley’s Exterminators considers launching a new pest control center with an initial cost of $900,000.

What is the projected cash flow?

The projected cash flows for the first three years are $60,000, $70,000, and $80,000, respectively. Calculating the Net Present Value (NPV) using a 9% cost of capital yields an approximate NPV of $43,989.

Beyond the third year, cash flows grow indefinitely by 3%. The present value of these cash flows amounts to roughly $1,143,643, constituting approximately 57% of the total cash inflows for the project.

Considering alterations in the long-term growth rate, if the cash flows grow by 1% or 0%, the NPV diminishes to about $32,408 and $20,826, respectively. This suggests that changes in the growth rate significantly affect the project's NPV.