Stonehedge Dairy will expand its organic yogurt production capacity at a cost of $10,000,000. The expansion will increase after-tax operating cash by $1.4 million dollars per year for the next 20 years. Stonehedge's WACC is 10%. To raise the $10,000,000 Stonehedge will need to issue new securities at a weighted average flotation cost of 10%. What is the NPV of the expansion?

Question

Quizplus · Accepted Answer

1. Calculate the annual cash flows:

Yearly increase in after-tax operating cash flow = $1.4 million

2. Calculate the present value of the cash flows:

PV of cash flows = $1.4 million / 10% = $14 million

3. Calculate the initial investment:

Initial investment = $10 million

4. Calculate the NPV:

NPV = PV of cash flows - initial investment = $14 million - $10 million = $4 million

5. Calculate the flotation cost:

Flotation cost = 10% of $10 million = $1 million

6. Adjust the initial investment:

Adjusted initial investment = initial investment + flotation cost = $10 million + $1 million = $11 million

7. Recalculate the NPV:

NPV = PV of cash flows - adjusted initial investment = $14 million - $11 million = $3 million

Therefore, the NPV of the expansion is $3 million. The best choice is B.

Stonehedge Dairy Will Expand Its Organic Yogurt Production Capacity at a Cost