- 15 Marks
FM – L2 – Q55 – Discounted Cash Flow
Question
Unified Energy Ltd is evaluating a project with the following cash flows:
| Year | 0 | 1 | 2 | 3 | 4 | 5 |
|---|---|---|---|---|---|---|
| GH₵000 | GH₵000 | GH₵000 | GH₵000 | GH₵000 | GH₵000 | |
| Sales | 7,400 | 8,300 | 9,800 | 5,800 | ||
| Wages | (550) | (580) | (620) | (520) | ||
| Materials | (340) | (360) | (410) | (370) | ||
| Licence fee | (300) | (300) | (300) | (300) | (300) | |
| Overheads | (100) | (100) | (100) | (100) | ||
| Equipment | (5,200) | (5,200) | 2,000 | |||
| Specialised equipment | (150) | |||||
| Working capital | (650) | 650 | ||||
| (5,200) | (6,150) | 5,960 | 6,960 | 8,370 | 7,160 | |
| Discount factor at 10% | 1.000 | 0.909 | 0.826 | 0.751 | 0.683 | 0.621 |
The company’s cost of capital is 10%.
Required:
Calculate the net present value (NPV) of the project and recommend whether it should be undertaken.
Answer
| Year | 0 | 1 | 2 | 3 | 4 | 5 |
|---|---|---|---|---|---|---|
| GH₵000 | GH₵000 | GH₵000 | GH₵000 | GH₵000 | GH₵000 | |
| Sales | 7,400 | 8,300 | 9,800 | 5,800 | ||
| Wages | (550) | (580) | (620) | (520) | ||
| Materials | (340) | (360) | (410) | (370) | ||
| Licence fee | (300) | (300) | (300) | (300) | (300) | |
| Overheads | (100) | (100) | (100) | (100) | ||
| Equipment | (5,200) | (5,200) | 2,000 | |||
| Specialised equipment | (150) | |||||
| Working capital | (650) | 650 | ||||
| (5,200) | (6,150) | 5,960 | 6,960 | 8,370 | 7,160 | |
| Discount factor at 10% | 1.000 | 0.909 | 0.826 | 0.751 | 0.683 | 0.621 |
| Present value | (5,200) | (5,590) | 4,923 | 5,227 | 5,717 | 4,446 |
NPV = +GH₵9,523,000
The project has a positive NPV. The project should be undertaken because it will increase the value of the company and the wealth of its shareholders.
- Tags: Cash Flows, Cost of Capital, Discounted cash flow, investment appraisal, NPV
- Level: Level 2
- Topic: Discounted cash flow
- Uploader: Samuel Duah