Quiz 17: Long-Term Investment Analysis


The tax relief competition between states seeking high-paying industrial jobs threatens to overpay for any conceivable net benefits. Alabama spent more than the $300 million in infrastructure development to obtain the $300 million Mercedes plant with 1,500 jobs. The investment in highways, rail, and sewers is higher than the actual investment by Mercedes. On the other hand, North Carolina has also heavily invested in airports and training worth $272.3 million to obtain the $300 million FedEx hub. In both cases, it appears that investments by states are comparatively higher than the direct benefit they get. But the investment by the state government should not be judged only in the direct sense. The benefits of government expenditure are intangible and indirect. The provision of airports and improved infrastructure paves the way for further development and the establishment of more subsidiary firms in the vicinity. Infrastructure development is key to economic development. The cost of investment by government should be compared to private plus social benefits emanating from infrastructure development.

From the given information, img img But $840,000,000 net cash flow over $900,000,000 net investment is not profitable. To know the annual cash flow over profitability, assume present value net cash flow to be $900 million or above. Now, at 7% discount rate the needed annual cash flow is $58,000,000 img At $63,000,000 annual cash flow, the profit would be zero. Therefore, above $63,000,000 annual cash flow is required in order to make the 500-megawatt plant profitable. The cost of coal is $88 and the cost of NG is $44. If the cost is considered then operating profit is img img The net cash flow per hour img For 20 hours a day or per day net cash flow img This adds up to $196 million per year. At 5% discount, it generates the revenue of img

The net investment ( NINV ) is 20000, net cash inflows img is 5000, expected life ( n ) is 5 years, marginal tax rate ( T ) is 0.4 and the firm's cost of capital ( k ) is 0.12. img img img a) We will calculate internal rate of return (IRR): img where ' r ' is internal rate of return. img In the table of annuity, 2.86 lies between 30.5 and 2.49, therefore r lies between img . img Now we will calculate net present value (NPV): img img b) Since IRR is greater than the cost of capital and net present value is greater than zero, the firm should accept the project.

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