- 20 Marks
FM – L2 – Q71 – Discounted Cash Flow
Calculate NPV for a project with GH₵3M equipment cost, 5-year cash flows, and 8% cost of capital, ignoring inflation and taxation.
Question
A company, Zenith Innovations Ltd, is considering an investment in a new project to manufacture and sell a new product with a five-year lifespan. The project requires an investment of GH₵3 million in equipment. The residual value of this equipment after five years will be 30% of its original cost.
The estimates of net cash flows from operations in each year of the project are as follows:
| Year | Net Cash Flow (GH₵) |
|---|---|
| 1 | 400,000 |
| 2 | 800,000 |
| 3 | 800,000 |
| 4 | 700,000 |
| 5 | 400,000 |
These cash flows are based on estimates that the annual increase in cash spending on fixed costs will be GH₵200,000, and the contribution/sales ratio from transactions will be 40%. The company’s cost of capital is 8%.
The management of Zenith Innovations Ltd is aware that actual cash flows could be higher or lower than expected, and sensitivity analysis should be carried out to establish the extent to which costs or revenues could differ from the estimate before the project ceases to have a positive NPV.
The investment in working capital will be minimal. Inflation and taxation should be ignored.
Required
(a) Calculate the net present value of the project.
(b) Carry out sensitivity analysis on the following items:
(i) The cost of the equipment, assuming that the residual value will be 30% of cost.
(ii) The residual value of the equipment.
(iii) Sales revenue.
(iv) Variable costs.
(v) Annual fixed costs.
(c) Comment on the risk in undertaking this project.
Find Related Questions by Tags, levels, etc.
- Tags: investment appraisal, NPV, Project Risk, Risk Assessment, Sensitivity Analysis
- Level: Level 2
- Topic: DCF: Risk and uncertainty
