General Motors has a weighted average cost of capital of 11%.GM is considering investing in a new plant that will save the company $30 million over each of the first two years,and then $25 million each year thereafter.If the investment is $150 million,what is the net present value (NPV)of the project?

Question

Quizplus · Accepted Answer

1. Calculate the present value of the savings over the first two years using the formula:
PV = Savings / (1 + WACC)^n, where n is the number of years
PV = $30 million / (1 + 0.11)^1 + $30 million / (1 + 0.11)^2
PV = $52.40 million

2. Calculate the present value of the savings for the remaining years using the formula:
PV = Savings / (WACC - growth rate)
PV = $25 million / (0.11 - 0.03) + $25 million / (0.11 - 0.03)^2 + $25 million / (0.11 - 0.03)^3 + ...
PV = $250 million

3. Calculate the total present value of the investment and savings using the formula:
NPV = PV of savings - initial investment
NPV = ($52.40 million + $250 million) - $150 million
NPV = $152.40 million - $150 million
NPV = $2.40 million

Since the NPV is positive, the investment in the new plant is expected to increase shareholder value and is therefore a good choice. The answer is D.

General Motors Has a Weighted Average Cost of Capital of 11%.GM