Question

You are the financial manager of the Crossrail 1 project in London. The Board overseeing the project, acting on behalf of the UK Government, has asked you to provide a financial analysis of the project for business planning purposes. With two years to go before the commencement of train operations, you have assembled the most recent estimates of the capital investment cost and net revenues, which were forecast 1 year ago. While the user benefits and ticket revenues are assumed to remain the same each year of the 60-year useful life, it is anticipated that maintenance costs will be higher in the final 30 years of the project. They are shown in Table 1.

Item of cash flow	Today (£bn)	Each year (for the first 30 years) (£bn)	Each year (for years 31 to 60) (£bn)
Capital investment	-9.4
User benefits (Includes Time savings, Traffic congestion relief)		0.843	0.843
Ticket revenues		0.3	0.3
Operational costs and maintenance		-0.422	-0.609

For projects such as Crossrail 1, the UK Government typically estimates a 60-year useful life and uses a discount rate of 3.5%.

a) What is the net present value (NPV) of the project?                            [ Select ]                       ["£15.04", "£8.83", "£7.36", "£16.76"]      

b) What is the payback period of the project?                            [ Select ]                       ["13.04", "8.22", "17.60", "7.49"]      

c) What is the internal rate of return (IRR) of the project?                            [ Select ]                       ["7.57%", "7.35%", "5.44%", "6.52%"]      

d) Based on your calculations is Crossrail 1 a viable project at the discount rate?                            [ Select ]                       ["Yes", "No"]      

You have been asked by the Board to present an analysis that incorporates more recent cash flow information about the Crossrail 1 project. Before the project becomes operational, the capital investment has been given a worse scenario estimate that is 35% above the forecast in table 1. The Board would like to see the analysis if the net cash inflows will also be 35% below expectation over the 60-year life whether under the existing hurdle rate of 3.5% it would remain viable.

a) What is the net present value (NPV) of the project?                            [ Select ]                       ["-£2.16", "£4.78", "£3.20", "-£1.80"]      

b) What is the internal rate of return (IRR) of the project?                            [ Select ]                       ["2.72%", "3.10%", "1.79%", "0.67%"]      

c) Based on your calculations is Crossrail 1 a viable project at the discount rate?                             [ Select ]                       ["Yes", "No"]      

Answer 1

a. Net Present Value of the project will be determined as follows:

Initial Investment = 9.4 bn.

Year 1 to Year 30 cash flows = 0.843 + 0.3 - 0.422

= 0.721 bn each year

Year 31 to Year 60 cash flows = 0.843 + 0.3 - 0.609

= 0.534 bn each year

Now we shall be using the financial calculator to get the Net Present Value:

Step 1 : Press 2ND CF

Step 2 : In CF₀ Enter Negative 9.4

Step 3 : In C01 Enter 0.721

Step 4 : In F01 Enter 30

Step 5 : In C02 Enter 0.534

Step 6 : In F02 Enter 30

Step 7 : Press NPV Key

Step 8 : Enter I = 3.5

Step 9 : Press Down Arrow

Step 10 : Press CPT

Which will give NPV of 7.36 bn

b. Payback Period of the project is the period in which we are able to recover our initial investment which in this case is 9.4 bn.

So our payback period = 9.4 / 0.721

= 13.04 years is the payback period.

c. Internal Rate of Return of the project is calculated by using the financial calculator as follows:

Step 1 : Press 2ND CF

Step 2 : In CF₀ Enter Negative 9.4

Step 3 : In C01 Enter 0.721

Step 4 : In F01 Enter 30

Step 5 : In C02 Enter 0.534

Step 6 : In F02 Enter 30

Step 7 : Press IRR Key

Step 8 : Enter CPT

which will give IRR of 7.35% Approximately

d. Since the Net Present Value of the project is positive hence the project crossrail 1 is a viable project.

a. If the projects Initial Investment increases by 35%, then new investment cost would be

9.4 bn + 35%

= 12.69 bn.

If the projects cash flows from year 1 to year 30 reduces by 35%, then new cash flows would be:

= 0.721 bn - 35%

= 0.46865

If the projects cash flows from year 31 to year 60 reduces by 35%, then new cash flows would be:

= 0.534 - 35%

= 0.3471

Now we shall be using the financial calculator to get the Net Present Value:

Step 1 : Press 2ND CF

Step 2 : In CF₀ Enter Negative 12.69

Step 3 : In C01 Enter 0.46865

Step 4 : In F01 Enter 30

Step 5 : In C02 Enter 0.3471

Step 6 : In F02 Enter 30

Step 7 : Press NPV Key

Step 8 : Enter I = 3.5

Step 9 : Press Down Arrow

Step 10 : Press CPT

Which will give NPV of - 1.80 bn

b. Internal Rate of Return of the project is calculated by using the financial calculator as follows:

Step 1 : Press 2ND CF

Step 2 : In CF₀ Enter Negative 12.69

Step 3 : In C01 Enter 0.46865

Step 4 : In F01 Enter 30

Step 5 : In C02 Enter 0.3471

Step 6 : In F02 Enter 30

Step 7 : Press IRR Key

Step 8 : Enter CPT

which will give IRR of 2.72% Approximately

c. Since the NPV of the project is negative, hence the project is not viable for investment.

Feel free to ask in case of any query relating to this question