A $3.2 Million Yes That Rests on Year 15: Taking a Freezer Facility to an Accept or Reject Decision
Student Name
American College of Education
FIN5003: Financial Decision Making
Module 3 Assignment
Instructor Name
July 17, 2028
The Project
Fenwick, the invented freezer-warehouse company whose decisions run through this course, proposes to build a 40,000-pallet freezer facility for $68 million: land and site work, the building, the carbon dioxide refrigeration system chosen in Module 1, racking and dock equipment. A frozen food manufacturer has offered a 15-year contract for 32,000 pallet positions, 80 percent of capacity, at $22 per pallet per month for storage plus handling fees of about $8.20 per pallet position per month, both rising 2.5 percent a year. Fenwick expects to lease the remaining 8,000 positions gradually to other customers, reaching 2,000 in year 2 and 4,000 from year 3, at slightly higher rates. The contract can be renewed at year 15 on terms to be negotiated.
The question is whether the facility is worth more than it costs, measured in today's dollars at Fenwick's cost of capital of 8.8 percent. A project with a positive net present value is a good investment only if the assumptions that produce the value are ones the company is willing to stand behind.
Free Cash Flows
Free cash flow is the cash the project generates after operating costs, taxes and ongoing investment, before financing. In year 1, revenue is about $11.6 million. Operating costs are labor of about $3.4 million, energy of $0.86 million from Module 1, property tax, insurance and maintenance of $1.3 million and site overhead of $0.7 million, leaving about $5.3 million of operating cash earnings before depreciation and taxes. Depreciation, the building over 39 years and equipment over 10, reduces taxable income; at a 25 percent tax rate, taxes are about $0.6 million, and free cash flow is about $4.7 million. Ongoing capital spending of about $0.4 million a year begins in year 2.
Free cash flow grows as occupancy rises and prices escalate, to about $6.9 million by year 15. At the end of year 20, the analysis assumes the facility could be sold for eight times that year's operating cash earnings, less 3 percent in selling costs, a terminal value of about $83 million. That multiple is below recent transaction levels for refrigerated warehouses of this kind in the case, because a 20-year-old facility will need reinvestment.
Net Present Value, Return and Payback
Discounting the initial $68 million outlay and 20 years of free cash flows, including the terminal value, at 8.8 percent gives a net present value of about $3.2 million. The internal rate of return, the rate that would make the project exactly break even in today's dollars, is about 9.3 percent, half a point above the cost of capital. The simple payback period, the time until cumulative cash flows recover the investment, is about 12 years, ignoring the terminal value.
The three measures tell a consistent but cautious story. The project creates value, but not much: a $3.2 million net present value on a $68 million investment is a margin of under 5 percent, and an internal rate of return only half a point above the hurdle leaves little room for error. Graham and Harvey (2001) reported that the discounted cash flow methods used in this paper are the ones finance chiefs lean on most, but a thin margin under either measure is a signal to look closely at where the value comes from.
What the Cash Flows Leave Out on Purpose
Three items are deliberately absent from the free cash flows. Interest on the debt that will finance part of the facility is excluded, because the cost of debt is already reflected in the weighted average cost of capital used to discount the flows; including interest as well would count the cost of financing twice. Brealey et al. (2023) describe this separation of the investment decision from the financing decision as a basic principle of capital budgeting: the project is valued as if all-equity financed, and the benefit of debt enters through the tax-adjusted discount rate. Financing choices are the subject of Module 5.
Sunk costs are also excluded. Fenwick has already spent about $900,000 on engineering studies and an option on the land. That money is gone whether or not the project proceeds and has no bearing on the decision. The option payment, however, does affect one cash flow: if Fenwick declines, it forfeits the option but avoids the remaining land payment, which is included in the $68 million. Finally, the analysis excludes any effect on Fenwick's existing warehouses. The manufacturer currently rents about 3,000 positions at Fenwick's older facility and would move them to the new one; those positions are expected to be re-leased within a year at similar rates, so the effect is small, but the net loss of about $0.7 million of revenue in year 1 has been deducted from the new facility's first-year cash flow in a sensitivity case. It reduces net present value by about $0.5 million.
Where the Value Comes From
Two sources dominate. The terminal value of about $83 million, received in year 20, is worth about $15.4 million today. Without it, the project's net present value would be deeply negative. The value therefore depends heavily on the facility's condition and the market for refrigerated space two decades from now. The second source is the contract renewal. If the manufacturer renews for only half its space in year 15, and Fenwick cannot re-lease the rest, net present value falls to about negative $16 million. The first 15 years of contracted cash flows do not, on their own, repay the investment at Fenwick's cost of capital.
The discount rate matters too. At 9.3 percent, the upper end of the range in Module 2, net present value is about zero; at 7.8 percent, the rate without the private company premium, it is about $11 million. Module 2 flagged that any decision depending on the premium should be discussed openly, and this one partly does.
Recommendation
Fenwick should accept the project, subject to two conditions that protect its main sources of value. First, the contract should be extended or strengthened before signing: either a 20-year initial term, or a 15-year term with a customer option to renew for five years at no less than 90 percent of the space, backed by a termination payment if it does not. Either would convert much of the renewal risk into contracted cash flow. Second, the facility's design should prioritize adaptability, such as a building that can be divided for multiple tenants, which supports the terminal value by making the building useful to more than one customer.
If the manufacturer refuses both conditions, Fenwick should consider delaying rather than rejecting outright. Dixit and Pindyck (1994) showed that when an investment is irreversible and its value uncertain, the option to wait for more information has value that a simple net present value calculation ignores. A year's delay would cost the customer relationship some goodwill but could be worth it if it secured better terms. The next module stresses the model further, moving each assumption until the decision changes.
References
Brealey, R. A., Myers, S. C., & Allen, F. (2023). Principles of corporate finance (14th ed.). McGraw Hill.
Dixit, A. K., & Pindyck, R. S. (1994). Investment under uncertainty. Princeton University Press.
Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2-3), 187-243. https://doi.org/10.1016/S0304-405X(01)00044-7
How this FIN 5003 Module 3 example is structured
FIN 5003 Module 3 in many sections runs one project to an accept or reject decision; your classroom's instructions decide the methods and the level of detail. This example sets out the investment and operating assumptions, builds free cash flows and reports net present value, internal rate of return and payback. It then decomposes the value, which is the step that turns a calculation into a decision, and ends with a recommendation whose conditions follow from the decomposition.
FIN5003 Module 3 questions, answered
What does FIN5003 Module 3 usually ask for?
FIN5003 Module 3 in many sections asks students to evaluate one capital project using free cash flows and methods such as net present value, internal rate of return and payback, and to recommend acceptance or rejection. Your classroom's instructions decide the project and methods.
Why decompose a project's net present value?
Breaking value into its sources, such as early cash flows, renewal assumptions and terminal value, shows which assumptions the decision depends on. A positive net present value that rests mostly on a distant terminal value deserves more scrutiny than one earned early.
Can a project with a positive NPV be delayed?
Yes. When an investment is irreversible and uncertain, waiting for better information or better terms can be worth more than investing now. The value of waiting is not captured in a simple net present value.
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