The development and construction of the project 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 10%, and the project’s beta is 1.2. DCC has no debt.

DNFC expects to spend $250,000 for land one year after 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, and it will be depreciated toward a salvage value of $50,000. The equipment has a five-year useful life with no salvage value. The equipment will be replaced at five-year intervals for $3 million upon each replacement.

Straight-line deprecation will be used (over years t = 4, t = 8, etc.). To support operations, DNFC expects to need $20,000 in 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 costs 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 for $420,000, The firm’s marginal tax rate is 21%. The value of the land is expected to be constant over the project's life, and the building can be sold for $150,000 at the end of the project.

What is the minimum amount the municipality would have to pay DNFC when the contract is awarded (t = 0) to make it worthwhile for DNFC to undertake the project?

 

Answer rating: 100% (QA)

To determine the minimum amount the municipality would have to pay DNFC at the start of the project ... View the full answer