Question

The Rodriguez Company is considering an average-risk investment in a mineral water spring project that has a cost of $130,000. The project will produce 800 cases of mineral water per year indefinitely. The current sales price is $143 per case, and the current cost per case is $110. The firm is taxed at a rate of 36%. Both prices and costs are expected to rise at a rate of 7% per year. The firm uses only equity, and it has a cost of capital of 14%. Assume that cash flows consist only of after-tax profits since the spring has an indefinite life and will not be depreciated.

What is the NPV of the project?
(Hint: The project is a growing perpetuity, so you must use the constant growth formula to find its NPV.)

Answer 1

The NPV of the project can be calculated using the formula for the present value of a growing perpetuity, which takes into account the cash flows, discount rate, and growth rate. In this case, the NPV can be calculated based on the after-tax profit, cost of capital, and expected rate of increase in sales price and cost per case.

Step-by-step explanation:

The NPV of the project can be calculated using the formula for the present value of a growing perpetuity. The formula is: NPV = CF / (r - g), where CF is the cash flow, r is the discount rate, and g is the growth rate. In this case, the cash flow is the after-tax profit from the project, which is equal to the sales price per case minus the cost per case, multiplied by the number of cases produced. The discount rate is the cost of capital for the firm, and the growth rate is the expected rate of increase in sales price and cost per case. Plugging in the values, the NPV of the project is:

NPV = (800 cases x ($143 - $110)) / (0.14 - 0.07)