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Calculating the net product value of a project and an expansion

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1) A firm is considering investing $10 million today to start a new product line. The future of the project is unclear however and depends on the state of the economy. The project will last 5 years. The yearly cash flows for the project are shown below for the different states of the economy. What is the expected NPV for the project if the cost of capital is 12%?
project outcome; chance of outcome; yearly cash flow
GOOD ; 25% ; $8.00
AVERAGE ; 50% ; $3.00
BAD ; 25% ; ($2.00)

2) A firm has a capital structure of 40% debt and 60% equity. Debt can be issued at a return of 10%, while the cost of equity for the firm is 15%. The firm is considering a $50 million expansion of their production facility. The project has the same risk as the firm overall and will earn $12 million per year for 6 years. What is the NPV of the expansion if the tax rate facing the firm is 40%?

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Solution Summary

This solution provides an Excel spreadsheet with the step-by-step process for calculating the net product value (NPV) for a project and for an expansion, taking different cost factors into account.

Solution provided by:
Radhika Lakshmi, MPhil
Education
  • MPhil, Madurai Kamaraj University
  • MCom, Annamalai University
  • IATA, International Air Transport Association
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