Question

You run a construction firm. You have just won a contract to build a government office complex. Building it will require an investment of $10.0 million today and $5.0 million in one year. The government will pay you S20.O million in one year upon the building's completion. Suppose the interest rate is 10.0%.

Required:
a. What is the NPV of this opportunity?
b. How can your firm turn this NPV into cash today?

Answer 1

a. Net Present Value = Present value of cashflows - Investment

Year 1 cash inflow = Receipts - Additional investment figure

= 20 million - 5 million

= $15 million

Net Present Value = (15,000,000 / (1 + 10%)) - 10,000,000

= $3,636,363.64

b. The total that the firm will receive from the government in today's value is:

= 20,000,000 / ( 1 + 10%)

= $18,181,818.18

The company can borrow this $18,181,818.18 now, assuming they can get it at a rate of 10%. When they are to pay it off in the next year, they will use the $20,000,000 that the government then pays them to pay off the loan.