Tag (SQ): Perpetuity

The Board of Zenith Solutions Ltd is considering the company’s capital investment options for the coming year, and also evaluating the following potential investments:

Investment A
This investment is similar to its current investments and requires an investment of GH₵60,000 now, GH₵40,000 for new capital equipment and GH₵20,000 for increases in working capital. This will be financed from Shareholders Funds. Sales next year would be 10,000 units, variable costs would be GH₵6 and the product would be sold for GH₵10. But due to entry of new competitors and technological improvements, the sales price would decline by 20% per annum thereafter, sales volume would fall by 10% and variable costs would fall by 20% per annum. Overheads attributed to the project would be GH₵15,000 per annum.
In year three the project would be wound up, working capital investment would be recovered and capital equipment sold off for 25% of its purchase costs the following year. Fixed costs include an annual charge of GH₵4,000 for depreciation.

Investment B
This is a long-term project in a totally new area, involving an immediate outlay of GH₵90,000, which they intend to borrow from their lenders at 6%. They expect net profits of GH₵12,000 next year, rising thereafter by 3% per annum in perpetuity.

Investment C
This is another long-term investment in a totally new area, involving an immediate outlay of GH₵25,000 which they intend financing by retained earnings. Expected annual net cash profits are as follows:
Years 1 to 4: GH₵3,000
Years 5 to 7: GH₵5,000
Year 8 onwards forever: GH₵7,000
The company discounts all projects lasting ten years duration or less at a cost of capital of 10% and all other projects at a cost of 13%. You may ignore taxation.

Required:
(a) Calculate the NPV of each project.

(b) Calculate the IRR of investments A and B (you may use 25% as the upper limit if you wish) and comment accordingly.