Question

An engineering company needs to decide whether to build a new factory. the cost of building the factory are 150 million euros initially, together with a further 100 million euros at the end of the next 2 years. annual operating cost are 5 million euros commencing at the end of the third year. annual revenue is predicted to be 50 million euros commencing at the end of the third year. if the interest rate is 6% compounded annually, find

a) the present value of the building costs
b) the present value of the operating cost at the end of 5 years
c) the present value of the revenue after 5 years
d) the net present value of the investment

Answer 1

To find the present value of the building costs, we need to calculate the present value of each cash flow separately and then sum them up. The initial cost of building the factory is 150 million euros, which is already the present value. The cost of 100 million euros at the end of the next 2 years needs to be discounted to the present value using the interest rate of 6%. The present value of the operating cost at the end of the third year is calculated by discounting the annual operating cost of 5 million euros for 3 years, again using the interest rate of 6%. The present value of the revenue after 5 years is calculated by discounting the annual revenue of 50 million euros for 5 years using the interest rate of 6%.

To find the present value of the building costs, we need to calculate the present value of each cash flow separately and then sum them up. The initial cost of building the factory is 150 million euros, which is already the present value. The cost of 100 million euros at the end of the next 2 years needs to be discounted to the present value using the interest rate of 6%. Since the cost is incurred after 2 years, we need to discount it twice. The present value of the operating cost at the end of the third year is calculated by discounting the annual operating cost of 5 million euros for 3 years, again using the interest rate of 6%. The present value of the revenue after 5 years is calculated by discounting the annual revenue of 50 million euros for 5 years using the interest rate of 6%.