Apex Ltd is considering whether to invest in the purchase of a new machine costing GH¢250,000. The machine will have a four-year life and a net disposal value of GH¢100,000 at the end of Year 4.
In addition, GH¢38,000 of working capital will be required from the start of the project, increasing to GH¢50,000 at the beginning of the second year. All the working capital will be recovered at the end of Year 4.
The project is expected to generate extra annual revenues of GH¢200,000 and incur annual cash operating costs of GH¢80,000 for each year of the project. Apex Ltd’s cost of capital is 10% after tax.
Corporation tax is charged on profits at 35%. Tax is payable in the year following the year in which the profits occur. There will be a 25% annual writing-down allowance on capital expenditure, for tax purposes. The tax-allowable depreciation is calculated by the reducing balance method.
Required
Calculate the NPV of the project and state whether or not it should be undertaken.
CVB Ltd is considering whether to invest in new equipment costing GH¢600,000. The equipment is expected to have an economic life of five years and will have no disposal value at the end of Year 5 (and no disposal costs).
CVB’s after-tax cost of capital is 15%. Tax is charged at an annual rate of 35% and is payable in the year following the year in which the taxable profits arise.
The following forecasts relate to the project under consideration:
Year
GH¢000
1
2
3
4
5
Sales income
250
250
300
350
400
Direct materials
50
55
58
64
70
Direct labour
25
25
30
30
35
Total direct costs
75
75
88
94
105
Depreciation
120
120
120
120
120
There will be tax allowances on the cost of the equipment, calculated at 25% each year on the reducing balance basis. The first depreciation tax allowance (capital allowance) would be claimed in year 0 (or very early in year 1).
Assume that:
(1) taxable profits are defined as income minus direct costs and capital allowances
(2) cash profits in each year = sales minus direct costs
Required
Calculate the net present value of the project and recommend whether or not the project should be undertaken.
Zest Ltd is considering whether or not to invest in a four-year investment project. The project will require the purchase of equipment costing GH¢800,000. This will have an estimated residual value of GH¢200,000 at the end of Year 4. The equipment will be depreciated by the straight-line method.
The profits before interest and tax from the project are expected to be GH¢400,000 each year. Tax is payable at 30% one year in arrears.
The equipment will qualify for capital allowances (tax depreciation allowances) of 25% each year, using the reducing balance method. The first claim for an allowance would be made against Year 0 profits.
The after-tax cost of capital is 15%.
Required:
Calculate the NPV of the project.
Kumasi Motors Ltd, a manufacturer of car accessories, is considering a new product line. This project would commence at the start of Kumasi Motors Ltd’s next financial year and run for four years. Kumasi Motors Ltd’s next year-end is 31st December 2005.
The following information relates to the project:
A feasibility study costing GH¢8 million was completed earlier this year but will not be paid for until March 20X6. The study indicated that the project was technically viable.
Capital expenditure
If Kumasi Motors Ltd proceeds with the project, it would need to buy new plant and machinery costing GH¢180 million to be paid for at the start of the project. It is estimated that the new plant and machinery would be sold for GH¢25 million at the end of the project.
If Kumasi Motors Ltd undertakes the project, it will sell an existing machine for cash at the start of the project for GH¢2 million. This machine had been scheduled for disposal at the end of 20X7 for GH¢1 million.
Market research
Industry consultants have supplied the following information:
Market size for the product is GH¢1,100 million in 20X5. The market is expected to grow by 2% per annum.
Market share projections should Kumasi Motors Ltd proceed with the project are as follows:
20X6
20X7
20X8
20X9
Market share
–
0.07
0.09
0.15
Subcontractors
Some of the work on the project would be performed by subcontractors who would be paid the following amounts:
Year
20X6
20X7
20X8
20X9
Payments to subcontractors (GH¢ million)
10
12
15
15
Fixed overheads
Incremental fixed overheads (all cash expenses) will be GH¢5 million in each of the four years of the project.
Labour costs
At the start of the project, employees currently working in another department would be transferred to work on the new product line. These employees currently earn GH¢3.6 million. An employee currently earning GH¢2 million would be promoted to work on the new line at a salary of GH¢3 million per annum. A new employee would be recruited to fill the vacated position.
As a direct result of introducing the new product line, employees in another department currently earning GH¢4 million would have to be made redundant at the end of 20X6 and paid redundancy pay of GH¢6 million at the end of 20X7.
Material costs
The company holds a stock of Material X which cost GH¢6.4 million last year. There is no other use for this material. If it is not used, the company would have to dispose of it at a cost to the company of GH¢2 million in 20X6. This would occur early in 20X6.
Material Z is also in stock and will be used on the new line. It cost the company GH¢3.5 million some years ago. The company has no other use for it, but could sell it on the open market for GH¢3 million early in 20X6.
Further information
The year-end payables are paid in the following year.
The company’s cost of capital is a constant 10% per annum.
It can be assumed that operating cash flows occur at the year-end.
Time 0 is 1st January 20X6 (t1 is 31st December 20X6, etc.)
Required
Calculate the net present value of the proposed new product line (work to the nearest million).
Accra-Nungua Transport Limited is considering an investment in a new machine that would be used to manufacture a new product at its existing production centre. The product and the machine are both expected to have an economic life of four years. The following estimates of revenues and costs have been made.
Year
1
2
3
4
Selling price per unit
GH¢8
GH¢9
GH¢10
GH¢10
Variable cost per unit
GH¢4
GH¢4.50
GH¢5
GH¢5.50
Sales volume (units)
30,000
40,000
50,000
20,000
It has been estimated that there would be no increase at all in fixed costs, except for depreciation of the new machine. The machine would cost GH¢40,000 at the end of its four-year life it would have no residual value.
The company has a cost of capital of 9%. Required
Calculate the net present value of the proposed project
Dambai Energy Ltd is considering whether to invest in either of two mutually-exclusive projects, Project 1 and Project 2. Both projects involve the purchase of machinery with a life of five years. Project 1: The machine would cost GH₵556,000 and would have a net disposal value of GH₵56,000 at the end of Year 5. The project would earn annual cash flows (receipts minus payments) of GH₵200,000. Project 2: The machine would cost GH₵1,616,000 and would have a net disposal value of GH₵301,000 at the end of Year 5. The project would earn annual cash flows (receipts minus payments) of GH₵500,000.
Dambai Energy Ltd uses the straight-line method of depreciation. Its cost of capital is 15%.
Ignore taxation, inflation, and investment in working capital.
Required
(a) For each of the two projects, calculate:
(i) the net present value, and
(ii) the internal rate of return to the nearest one per cent.
(b) State which project, if any, you would select for acceptance.
It is said that of all the capital investment evaluation approaches, the Payback (PB) and Accounting rate of return (ARR) methods are widely used in practice. But these methods are not without limitations.
Required:
(a) State TWO justifications of payback period and ONE justification of ARR for their popularity in practice as investment appraisal techniques.
(b) Outline TWO limitations each for payback and ARR, as investment appraisal techniques.
(a) The PPP arrangements are explained below:
(i) Operate and Maintain (O&M)
(ii) Build-Operate Transfer (BOT)
(iii) Build Transfer and Operate (BTO)
(iv) Rehabilitate, Operate and Transfer (ROT)
(v) Service Concession
(b) Explain five types of risk associated with a PPP arrangement that allocation between the parties.
