Question:
The G&P Corporation is thinking of buying a plant to make packets of laundry detergent. The current date is 12/31/X0. The plant costs $10 million. It will be ready for production immediately and is expected to last for three years. At the end of its life the salvage value will be $3 million. The plant will produce 1 million packets of laundry detergent during each year. The price of each packet is currently (i.e. on 12/31/X0) $5 and is expected to increase at 4 percent per year. The raw materials currently cost $1 per packet and are expected to increase at 3 percent per year. The total labor costs to run the plant are currently $200,000 per year and these are expected to remain constant. If the plant is bought, the extra head office expenses are expected to be $100,000 in the first year, $150,000 in the second year and $175,000 in the third year. All costs and expenses are tax deductible. All figures are given in nominal terms. The firm has a corporate tax rate of 35 percent and uses straight line depreciation. The nominal opportunity cost of capital for this type of project is 12 percent. The nominal debt rate is 6 percent. Assume all cash flows occur at year's end and that the firm has profitable ongoing operations.
a) Give a table of cash flows with one column for each year's end.
b) Calculate the plant's base-case NPV at 12/31/X0 assuming it is all-equity financed.
c) Calculate the plant's (adjusted) PV at 12/31/X0 assuming that in every year the optimal debt capacity of the firm is increased by 40 percent of the project's base-case PV and this is the only financing side effect.