Reference no: EM132493101

As a new actuary, you are reviewing a project analysis done by another actuary at your firm, and you note that he has computed a net present value of $ 260 million for the 3-year project. The project has expected revenues of $ 2.5 billion each year for the next 3 years and a cost of capital of 10%. You discover two mistakes in the analysis:

a. The analyst forgot to include working capital requirements when computing the net present value. You estimate that working capital will be 10% of revenues and will have to be invested at the beginning of each year starting at t=0. . In addition, you believe that you will be able to recover all working capital at the end of the project life when t=3. .

Question 1: Calculate the effect on the net present value of incorporating working capital correctly and give the new NPV for the project.

b. You also notice that the analyst treated the initial investment of $3 billion in the project as a tax deductible expense. The US law does not allow this. He should have depreciated it straight line down to a salvage value of zero over the three years. The marginal tax rate is 30%.

Question 2: Calculate the effect on the net present value of depreciating the initial investment, rather than treating it as an expense at t=0 and indicate the effect on the original NPV.