MetalMouth received a $2 million government innovation grant. MetalMouth invested the grant money and developed a system to remove metal contaminants from storm water in shipyards. The firm estimates that each shipyard spends $600,000 a year on storm water clean-up efforts. If MetalMouth is able to sign up and retain four shipyards from the first year onwards, what is the present value (PV) of the project (net of investment) if the cost of capital for MetalMouth is 15% per year? Assume a cost of operations and other costs for SAP equal 40% of revenue.

Question

Quizplus · Accepted Answer

1. MetalMouth's revenue per shipyard per year will be $600,000 (the amount each shipyard spends on clean-up efforts).
2. MetalMouth will initially have a total revenue of $2 million from the government innovation grant, which will be invested to develop the storm water removal system.
3. The total revenue (TR) that MetalMouth will generate in the first year will be $2 million + ($600,000 x 4) = $4.4 million.
4. The cost of operations and other costs for MetalMouth are expected to be 40% of revenue, which means that the company's total costs (TC) for the first year will be $4.4 million x 40% = $1.76 million.
5. MetalMouth's gross profit (GP) for the first year will be TR - TC = $4.4 million - $1.76 million = $2.64 million
6. To calculate the present value of the project, we need to calculate the net present value (NPV) of MetalMouth's cash flows over the first four years. Assuming that MetalMouth will be able to retain all four shipyards from the first year onwards, the NPV can be calculated as follows:
Year 1: GP = $2.64 million, NPV = $2.3 million
Year 2: GP = ($600,000 x 4) x 60% = $1.44 million, NPV = $1.16 million / (1 + 0.15)^2 = $0.85 million
Year 3: GP = ($600,000 x 4) x 60% = $1.44 million, NPV = $1.16 million / (1 + 0.15)^3 = $0.73 million
Year 4: GP = ($600,000 x 4) x 60% = $1.44 million, NPV = $1.16 million / (1 + 0.15)^4 = $0.63 million
7. The total present value of the project (net of investment) is the sum of the NPVs for each year, plus the initial investment of $2 million:
PV = $2.3 million + $0.85 million + $0.73 million + $0.63 million - $2 million = $2.51 million.
Therefore, the present value (PV) of the project (net of investment) is $7.6 million (rounded to the nearest tenth).

MetalMouth Received a $2 Million Government Innovation Grant