Question

The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is “looking up.” As a result, the cemetery project will provide a net cash inflow of $180,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 4 percent per year forever. The project requires an initial investment of $2.2 million.

If the company requires a return of 11 percent on such undertakings, what is the NPV of the project?

Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.18.

The company is somewhat unsure about the assumption of a 4 percent growth rate in its cash flows. At what constant growth rate would the company just break even if it still required a return of 11 percent on its investment?

Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.

Answer 1

The NPV of the project given the parameters is $371,428.57. To break even with an 11% required return, the cash flows would need to grow at 3.18% per year.

Step-by-step explanation:

To determine the net present value (NPV) of the project, we use the formula NPV = (Cash Flow / (1 + r)^n) - Initial Investment, where Cash Flow is the expected cash flow each year, r is the discount rate, and n is the period. In this case, since the cash flows are growing in perpetuity, we use the formula for a perpetuity with growth: NPV = (Cash Flow / (r - g)) - Initial Investment, where g is the growth rate. With a cash flow of $180,000, required return (r) of 11%, growth (g) of 4%, and an initial investment of $2,200,000, the NPV is NPV = ($180,000 / (0.11 - 0.04)) - $2,200,000, which equals $2,571,428.57 - $2,200,000 = $371,428.57.

To find the break-even growth rate, we set NPV equal to zero and solve for g. NPV = (Cash Flow / (r - g)) - Initial Investment = 0. This simplifies to (Cash Flow / Initial Investment) = r - g. Plugging in the numbers ($180,000 / $2,200,000) = 0.11 - g, we solve for g which gives us a break-even growth rate of 3.18%.