Question

1. Agbada Inc is considering a new investment which would start immediately and last four years. The company has gathered the following information: Asset cost – $160,000 Annual sales are expected to be 30,000 units in Years 1 and 2 and will then fall by 5,000 units per year in both Years 3 and 4. The selling price in first-year terms is expected to be $4.40 per unit and this is then expected to inflate by 3% per annum. The variable costs are expected to be $0.70 per unit in current terms and the incremental fixed costs in the first year are expected to be $0.30 per unit in current terms. Both of these costs are expected to inflate at 5% per annum. The asset is expected to have a residual value (RV) of $40,000 in money terms. The project will require working capital investment equal to 10% of the expected sales revenue. This investment must be in place at the start of each year. Corporation tax is 30% per annum and is paid one year in arrears. 25% reducing balance writing-down allowances are available on the asset cost. General inflation is 4% and the real cost of capital is 7.7% $12,000 has already been spent on initial research. Required:

(a) Calculate the NPV of the proposed investment.

(b) Graphically show the internal rate of return of the project.

(c) Using solver find the Internal rate of return of the project.

(d) Using scenario manager find the NPV at the following asset cost; $ 140,000; $ 150,000; $ 170,000 and $ 180,000.

(e) Explain how firms create positive net present value projects.

Answer 1

Year	units	salling price	v.cost	f.cost	amt	dep.	PBT
1	30000	4.400	0.700	0.30	102000	40000	62000
2	30000	4.532	0.735	0.315	104460	30000	74460
3	25000	4.668	0.772	0.331	89125	22500	66625
4	25000	4.808	.810	0.347	91275	16875	77475

particulare	year1	year2	year3	year4
profit before tax	62000	74460	66625	77475
profit after tax (70%)	43400	52122	46638	54233
add: depriciatiation	40000	30000	22500	16850
cash flaow	83400	82122	69138	71083
pv [email protected]%	0.929	.862	0.800	0.743
present value	77479	70789	55310	52814

particulare	year1	year2	year3	year4
working capital	13200	13596	11670	12020
pv factores	0.700	0.735	0.772	0.810
present value	9240	9993	9009	9736
			total	37978

computation of net present value= pv of cash in flow- pv of cash out flow

pv of cash in flow= pv of free cash flow+pv of salvage

=256392+40000*0.743  

=286112

pv of cash out flow= 160000*1+12000*1+37978 = 209978

NPV=286112-209978

=76134