Final answer:
Gold Corporation should calculate the net present value (NPV) of the future cash flows from the new manufacturing plant, discounted back at the WACC of 15%, to decide whether to undertake the project.
Step-by-step explanation:
The question relates to whether Gold Corporation should undertake a project to build a new manufacturing plant, considering the free cash flows it will generate and the initial investment required. To determine this, we need to conduct a net present value (NPV) analysis using the given Weighted Average Cost of Capital (WACC) of 15%.
The NPV calculation takes the free cash flows expected in different years and discounts them back to their present value using the WACC. The formula to calculate each year's present value (PV) of free cash flows is PV = FCF / (1 + WACC)^t, where FCF is the free cash flow in a given year, and t is the year number.
For Gold Corporation:
- Initial cost of plant: -$100,000
- Free cash flows: $40,000 in years 1 and 2, and $60,000 in years 3 and 4
NPV calculation:
- Year 1 PV = $40,000 / (1 + 0.15)^1
- Year 2 PV = $40,000 / (1 + 0.15)^2
- Year 3 PV = $60,000 / (1 + 0.15)^3
- Year 4 PV = $60,000 / (1 + 0.15)^4
Summing the PVs of all future cash flows and subtracting the initial investment:
NPV = (Sum of PVs) - Initial Investment
The NPV is then compared to zero to make the investment decision. If the NPV is greater than zero, the project should be undertaken as it is expected to add value to the company. If NPV is less than zero, the project should not be undertaken. Note that the $80,000 spent on searching for the plant location is a sunk cost and should not affect the NPV calculation as it will be spent regardless of the decision.