Woodland Enterprises plans to invest GH₵7 million in a new product. Net contribution over the next five years is expected to be GH₵4.2 million per annum in real terms. Marketing expenditure of GH₵1.4m per annum will also be needed. Expenditure of GH₵1.3m per annum will be required to replace existing assets which will now be used on the project but are getting to the end of their useful lives. This expenditure will be incurred at the beginning of each year. Additional investment in working capital equivalent to 10% of contribution will need to be in place at the start of each year. Working capital will be released at the end of the project. The following forecasts are made of the rates of inflation each year for the next five years:
Contribution
Marketing
Assets
General prices
8%
3%
4%
4.70%
The real cost of capital of the company is 6%. All cash flows are in real terms. Ignore tax.
Required:
Calculate the net present value of the project and appraise whether it is a worthwhile project.
(a) TechNova Ltd, a software company, has developed a new game “Zestora” which it plans to launch in the near future. Sales volumes, production volumes, and selling prices for “Zestora” over its four-year life are expected to be as follows:
Year
Sales and production (units)
Selling price (GH₵ per game)
1
15,000
45
2
25,000
40
3
20,000
38
4
10,000
35
Financial information relating to the production of Zestora:
Item
GH₵ per game
Direct materials
6
Direct labour
8
Variable production overheads
4
Additional information:
Annual fixed production overheads will be GH₵150,000.
Initial investment in equipment will be GH₵800,000.
Additional working capital of GH₵50,000 will be needed at the beginning of the project and will be released at the end of year four.
Tax at the rate of 25% is payable on profits one year in arrears.
Capital allowance is available at 25% per year on a reducing balance basis.
TechNova Ltd’s cost of capital is 10%.
The equipment will have no residual value at the end of year four.
Required: Calculate the net present value of the proposed investment and comment on your findings.
Coastline Plc is considering whether to invest in a project whose details are as follows.
The project will involve the purchase of equipment costing GH¢2,000,000. The equipment will be used to produce a range of products for which the following estimates have been made.
Year
Average unit sales price
Average unit variable cost
Incremental fixed costs
Sales volume (units)
1
GH¢73.55
GH¢50
GH¢1,200,000
65,000
2
GH¢76.03
GH¢45
GH¢1,200,000
110,000
3
GH¢76.68
GH¢45
GH¢1,200,000
125,000
4
GH¢81.86
GH¢45
GH¢1,200,000
80,000
The sales prices allow for expected price increases over the period. However, cost estimates are based on current costs and do not allow for expected increases in costs. Inflation is expected to be 3% per year for variable costs and 4% per year for fixed costs. The incremental fixed costs are all cash expenditure.
Tax on profits is at the rate of 30%, and tax is payable in the same year.
The cost of capital is 10%.
ZQR Ltd, a manufacturing company, is considering a proposal to invest in machinery that it will use to increase its output and sales by 10,000 units in each of the next five years. The full purchase cost of the machinery would be GH¢225,000. This price includes a payment of GH¢20,000 made 12 months ago to the machinery supplier for a non-refundable down-payment for purchase of the machinery.
The company currently makes and sells a single product. This has a selling price of GH¢15 per unit and at present-day prices the direct costs per unit are GH¢3.75 for material and GH¢2.50 for labour. Incremental production overheads (all cash expenses) would be GH¢37,500 in each year, at current price levels.
Assume that all cash flows occur at the end of the year to which they relate.
ZQR’s cost of capital is 10%.
Required
(a) Calculate the NPV of the project, ignoring inflation.
(b) Calculate the NPV of the project, at a cost of capital of 10%, taking the following inflationary increases in revenues and costs into consideration:
Because of inflation, selling prices will rise by 7% in each year.
Material costs will rise by 5% each year, labour costs by 6% each year and overheads by 2% each year.
Comment on the differences in your results, compared with the NPV you calculated in part (a)
ZENITH LTD
(a) Calculate the NPV of an investment with the following estimated cash flows, assuming a cost of capital of 8%:
Years
Annual cash flow
0
(3,000,000)
1–4
500,000
5–8
400,000
9–10
300,000
11 onwards
100,000
ZENITH LTD
(b) The cash flows for an investment project have been estimated at current prices, as follows:
Year
Equipment
Revenue
Running costs
0
(900,000)
1
800,000
(400,000)
2
800,000
(350,000)
3
400,000
(300,000)
4
400,000
(300,000)
It is expected that the cash flows will differ because of inflation. The annual rates of inflation are expected to be:
Equipment value: 4% per year
Revenue: 3% per year
Running costs: 5% per year.
The cost of capital is 12%.
Required
(a) Calculate the NPV of the project ignoring inflation.
(b) Calculate the NPV of the project allowing for inflation.
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).
