Two years ago Red Bricks Ltd. bought a parcel of land for $200,000 and spent $40,000 laying a foundation for a new factory. Work was stopped because of a recession. Now that the economy has improved, Red Bricks is considering starting the expansion again. The latest numbers suggest it can complete construction using 1 million of its own bricks that cost $0.50 to make but could have been sold for $0.75 each. The company could use 10 of its own idle workers for 40 hours per week for 10 weeks, each earning $15 per hour. These workers would not be laid off if the firm decides against expansion. In addition, another 20 new hires would have to be done for the same period, but these employees would only earn $10 per hour. New machines costing $5,000,000 would be purchased. The new factory is expected to produce $2,000,000 cash flow per year for 10 years. What is the net present value of the project if Red Brick's hurdle rate is 14%?

Question

Quizplus · Accepted Answer

The net present value (NPV) is calculated by considering the initial investment, opportunity costs, and the present value of future cash flows. The initial investment includes the cost of bricks ($750,000 opportunity cost), labor costs for idle workers ($0, as they are already paid), labor costs for new hires ($80,000), and new machines ($5,000,000). The present value of future cash flows is calculated using the formula for the present value of an annuity. Subtracting the initial investment from the present value of cash flows gives an NPV of approximately $4.2 million.

Two Years Ago Red Bricks Ltd