Ford Motors expects a new hybrid-engine project to produce incremental cash flows of $100 million each year and expects these to grow at 4% each year.The upfront project costs are $900 million and Ford's weighted average cost of capital is 9%.If the issuance costs for external finances are $10 million,what is the net present value (NPV)of the project?

Question

Quizplus · Accepted Answer

To calculate the NPV, we need to discount the cash flows using the weighted average cost of capital (WACC):

NPV = -Initial Investment + (PV of Cash Flows)

where,
PV of Cash Flows = (Incremental cash flows in Year 1) / (1 + WACC)^1 + 
                    (Incremental cash flows in Year 2) / (1 + WACC)^2 +
                    ...
                    (Incremental cash flows in Year n) / (1 + WACC)^n

Here, n = infinity (since cash flows are expected to grow at a constant rate forever)

PV of Cash Flows = (100) / (0.09 - 0.04) = $2000 million

NPV = -900 - 10 + 2000 = $1090 million

Therefore, the best choice is D, as it gives the correct NPV of the project.

Ford Motors Expects a New Hybrid-Engine Project to Produce Incremental