EnVo is evaluating a proposal to move some manufacturing operations from an obsolescent plant in Mexico to a new facility in China.The new facility will cost $58 million to open and is expected to result in savings of $16 million per year for the first five years.At the end of five years, Porter will decide either to close the plant in China or to keep it indefinitely.If EnVo closes the plant, the building and equipment can be sold for $20,000,000.If the plant is kept, assume that the $16 million turns into a perpetuity.There is a 30% chance the plant will be closed and a 70% chance it will be kept.Calculate the expected NPV of the project.Use a discount rate of 12%.
A)$75.32 million
B)$30.32 million
C)$56.04 million
D)$114.04 million

Question

Quizplus · Accepted Answer

First, we need to calculate the NPV of the project if the plant is kept indefinitely:

NPV = (CF/(r-g)) - Initial Investment
where CF = annual savings = $16 million, r = discount rate = 12%, g = perpetual growth rate = 0% (assumed), and Initial Investment = $58 million.

NPV = (16/(0.12-0)) - 58 = $61.33 million

Next, we need to calculate the expected NPV of the project:

Expected NPV = (Probability of plant being kept x NPV if plant is kept) + (Probability of plant being closed x Sale value of assets)

Expected NPV = (0.70 x $61.33 million) + (0.30 x $20 million)

Expected NPV = $56.04 million

Therefore, the expected NPV of the project is $56.04 million, and the best choice is C.

EnVo Is Evaluating a Proposal to Move Some Manufacturing Operations