Problem:
Construction projects are often analyzed through capital budgeting. Let's use this example as a guideline to understand the net present value of projects. So, let's assume that the "Project" is a new manufacturing plant. Costs associated with the project are $4 million to build the plant and $1 of costs to run the plant every year. This would include the cost of electricity, water, labor, and other miscellaneous expenses. You expect to produce and sell 30 million parts every year for revenues of $5 million a year. The manufacturing and selling costs of your parts are $1 million per year. Assuming there are NO other costs or revenues and that this project is to run for 10 years:
1. What are the cash inflows and outflows for year 0 and years 1 to 10?
2. What is the net present value of the project if the required rate of return (also known as the discount rate or cost of capital) is 10%?
3. Should this project be accepted?