Question

Question 1: Rucas plc is a telecommunications and information technology manufacturing company based in the country of Hambia. The currency of Hambia is the Aira (AR). The company is considering manufacturing the smart phone model H3XG. If the operation were to be set up, the equipment would be purchased for AR3.5 million and the market price at the end of expected 4-year project life will be AR1.25m. The mobile phone will sell for an initial price of AR950 per unit in the first year and this price will increase in line with inflation in Hambia which is expected to continue at the current rate of 6% per annum. It is expected that 3,000 H3XG phones will be sold in the first year, increasing at a rate of 3% each year. The costs of manufacturing H3XG will consist of variable costs which will be 60% of selling price per unit and incremental fixed overheads of AR60,000 per annum. The costs will increase in line with inflation in Hambia. The working capital equal to 10% of expected sales value for the year will be required at the beginning of each year. At the end of the project the working capital will be recovered. Corporation tax in Hambia is 25%, payable one year in arrears. The tax allowable depreciation is at 20% on a reducing balance method. The required rate of return for the project is 15%. YOU ARE REQUIRED TO:

(a) Estimate the net present value of the project, and recommend, on the basis of NPV, whether the project should be undertaken. (maximum word count for the recommendation 50 words).

(b) Explain why NPV is preferable to payback period as a project selection criterion. (maximum word count 100 words).

(c) Discuss any four non-financial objectives that a company should consider when making investment decisions. (maximum word count 100 words). TOTAL 50 MARKS

Answer 1

(a

(b)  Unlike the NPV method, the payback method fails to account for the time value of money or project risk, but rather assumes all financial aspects of a project will progress as planned. In addition, the payback method fails to consider cash flow after the payback period.

(c)  Four non-financial objectives that a company should consider when making investment decisions :

- Increasing customer base is the non-financial objectives behind investment decisions.

- Diversifying the company's portfolio could be non-financial objectives behind investment decisions.

-  Matching industry standards and good practice could be non-financial objectives behind investment decisions.

- Serving community could be non-financial objectives behind investment decisions.

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