Building a Bridge - 6

Quantitative Finance Level 2

You are the project manager of a construction company. You are considering building a bridge across the river. You estimate that the construction project will take 3 years, with $10 million due each year. Upon completion of the project, the tolls collected from the bridge will be valued at $4 million per year. It is estimated that the bridge will last for 10 years, before it will need to be replaced. The cost of dismantling the bridge will be offset by the price of the reclaimed materials.

Assume that the discount rate is 5% per year. The Net Present Value is calculated in the 0th year.

6) It seems like at the cost of $30 million, we can make a revenue of $40 million. Is this project a good idea?

No Yes

View wiki
Calvin Lin by Calvin Lin

This section requires Javascript.
You are seeing this because something didn't load right. We suggest you, (a) try refreshing the page, (b) enabling javascript if it is disabled on your browser and, finally, (c) loading the non-javascript version of this page . We're sorry about the hassle.

2 solutions

Dianelle Ku
Apr 19, 2015

Our investment is worth 10+10/1.05+10/1.05^2~=28.5941 mln. The total revenue is 4/1.05^3+4/1.05^4+...+4/1.05^10~=23.4493 mln. NPV = 23.4493-28.5941, it is obviously negative so the project isn't worth starting.

1 Helpful 0 Interesting 0 Brilliant 0 Confused

Although the result is still the same, assuming the tolls collected at the end of the year after the completion FOR THE NEXT 10 YEAR, the pv of tolls should be 4/1.05^4+4/1.05^5...+4/1.05^13=26.68. It is also not clear if the cost of 10m would occur in the beginning of the year (which is your calculation) or at the end of the year (10/1.05+10/1.05^2+10/1.05^3=27.23) either way, the project is not worth taking.

Eggy Putera - 6 years, 1 month ago
Chew-Seong Cheong
Mar 26, 2015

It is not a good investment because the Net Present Value of the project is n e g a t i v e . \boxed{negative.} See solution of Building a Bridge - 5 .

1 Helpful 0 Interesting 0 Brilliant 0 Confused

Indeed. It is not important what the total revenue / cashflow for the project is, but instead what the net present value of these cashflows are.

For example, paying out $1 million now and getting $1 million in 10 years is clearly a negative proposition, despite the cashflow zeroing out. When we think in terms of net present value, this make it obvious.

Calvin Lin Staff - 6 years, 2 months ago

0 pending reports

×

Problem Loading...

Note Loading...

Set Loading...