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Net Present Value and IRR: 20 Year Expansion Project

A 20 year expansion project has a depreciable capital outlay of $50 million (straight line depreciation). It also has additional net working capital needs of $5 million. The project is expected to generate revenues of $30 million and expenses of $23 million during each year of the project. There is a debug expense of $3 million in the first year and a salvage value in year 20 is estimated to be $5 million. The tax rate is 30%. The WACC is 11.333%. What is the NPV? Find the IRR of the project. Find the breakeven level of revenues.

Solution Preview

First, analyze the information given in the problem.

Number of years of the expansion project n = 20
Initial investment = $50 (million) [all numbers in this problem are in $millions] capital outlay + $5 million increase in net working capital + $3 million debug expense = 50 + 5 + 3 = $58 (this is the negative cash flow at the beginning of the project)
Depreciation = straight line, meaning equal amounts of depreciation every year for 20 years = 50/20 = $2.5 million depreciation annually. Note that the increase in net working capital ($5 million) and the extra debug expense ($3 million) are not depreciated.
Revenues = $30 million for years 1-20
Expenses = $23 million for years 1-20
Salvage value of the initial investment in year 20 = $5 million
Tax rate = 30%
WACC (Weighted Average Cost of Capital) = 11.333%

Next, look at the questions.

Q1. What is the NPV ...

Solution Summary

This solution includes a step-by-step solution to how to calculate NPV (net present value), IRR (internal rate of return), and the breakeven point for a 20 year expansion project.