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The Doug E. Nuff Construction Company is considering a 33-year project that the government wants it to undertake

The Doug E. Nuff Construction Company is considering a 33-year project that the government wants it to undertake
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C4. (Excel: NPV and cost of capital) The Doug E. Nuff Construction Company is considering a 33-year project that the government wants it to undertake. Development and construction will take 3 years, and the project will operate for 30 years. The riskless rate is 5%; the rate of return on the market portfolio is 12%; and the project’s beta is 1.3. Doug’s firm has no debt. Doug expects to spend $250,000 for land, 1 year from the date the contract is awarded (t = 1). Construction of the building will cost $2 million, and the equipment will cost $3 million, both of which will be cash outflows at t = 2. The life of the building is 30 years, with a salvage of $50,000, while the equipment has a 5-year useful life with no salvage value. The equipment will be replaced at 5-year intervals at a cost of $3 million upon each replacement. Straight-line depreciation will be used (over years t = 4 through t = 8, initially). To support operations, Doug expects to need $20,000 additional cash, to invest $60,000 in accounts receivable and $80,000 in inventory, and to maintain $60,000 in accounts payable. The investment in net working capital occurs at the start of operations (t = 3). The revenues from the project will amount to $800,000, fixed cost will be $100,000, and variable costs will be $150,000—all on an annual basis. At the end of the project, the firm is expected to restore the surrounding area at a cost of $420,000. The tax rate is 40%. The value of the land is expected to be constant over the life of the project, and the building can be sold for its net book value at the end of the project. What is the minimum amount that the government would have to pay Doug at the time the contract is awarded (t = 0) to get him to undertake the project?

 

FILE: MS WORD

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