Reference no: EM133105054

Question - A medium-sized production company with extensive operations in many parts of the country, is considering starting a new business that takes advantage of a new business opportunity. To take advantage of this, one must invest in hardware and equipment that cost 1,500 million. kr. but in addition, this equipment needs to be installed, which is estimated to cost ISK 500 million. kr. Estimates assume that the life of the investment will be 10 years. After that time, it is assumed that machinery and equipment can be sold for ISK 500 million. kr. Sales losses can be offset against the profit for the year. The depreciation stock can be depreciated on a straight-line basis over 10 years, but not more than about 90% of the depreciation stock. The investment also requires an increase in current assets in the amount of ISK 80 million. kr. which are released again when this activity is stopped. It is estimated that sales revenue from this new business opportunity will be ISK 4,000 million. kr. in a year. Variable costs are estimated at 55% of sales revenue. The company's rate of return for this project is 12% and the tax rate is 22%.

a) What is the net cash flow (NCF) at the beginning (ie when t = 0)?

b) What is the cash flow from operations (OCF) in the third year of the project, (ie when t = 3)?

c) What is the net cash flow (NCF) in the last year of the project, (ie when t = 10)?

d) What is the internal rate of return (IRR) of this project and then the answer is whether it pays to invest in this project?