Question

In: Finance

DP Plc is considering whether to purchase a piece of land close to a major city...

DP Plc is considering whether to purchase a piece of land close to a major city airport. The land
will be used to provide 600 car parking spaces. The cost of the land is K6,000,000 but further
expenditure of K2,000,000 will be required immediately to develop the land to provide access
roads and suitable surfacing for car parking. DP Plc is planning to operate the car park for five
years after which the land will be sold for K10,000,000 at Year 5 prices. A consultant has prepared
a report detailing projected revenues and costs.
Revenues
It is estimated that the car park will operate at 75% capacity during each year of the project. Car
parking charges will depend on the prices being charged by competitors. There is a 40% chance
that the price will be K60 per week, a 25% chance the price will be K50 per week and a 35%
chance the price will be K70 per week.
DP Plc expects that it will earn a contribution to sales ratio of 80%.
Page 5 of 5
Fixed Operating Costs
DP Plc will lease a number of vehicles to be used to transport passengers to and from the airport. It is expected that the lease costs will be K50,000 per annum.
Staff costs are estimated to be K350,000 per annum.
The company will hire a security system at a cost of K100,000 per annum.
Inflation
All of the values above, other than the amount for the sale of the land at the end of the five year period, have been expressed in terms of current prices. The vehicle leasing costs of K50,000 per annum will apply throughout the five years and is not subject to inflation.
Car parking charges and variable costs are expected to increase at a rate of 5% per annum starting in Year 1.
All fixed operating costs excluding the vehicle leasing costs are expected to increase at a rate of 4% per annum starting in Year 1.
Other Information
The company uses net present value based on the expected values of cash flow when evaluating projects of this type.
DP Ltd has a money cost of capital of 8% per annum.
DP’s Financial Director has provided the following taxation information:
(1) Tax depreciation (Capital allowances) is not available on either the initial cost of the land or the development costs.
(2) Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises, the balance is payable in the following year.
All cash flows apart from the initial investment of K8,000,000 should be assumed to occur at the end of the year.
Required:
(a) Evaluate the project from a financial perspective. You should use net present value as the basis of your evaluation and show your workings in K’000. [14 Marks]
(b) Calculate the internal rate of return (IRR) of the project. [5 Marks]
The main reason why discounted cash flow methods of investment appraisal are considered theoretically superior is that they take account of the time value of money.
Required:
(c) Explain the THREE elements that determine the ‘time value of money’ and why it is important to take it into consideration when appraising investment projects. [6 Marks]
[TOTAL: 25 MARKS]

Solutions

Expert Solution

​​​​​​


Related Solutions

A city is considering buying a piece of land for $500.000 and construction an office complex...
A city is considering buying a piece of land for $500.000 and construction an office complex on it. Their planning horizon is 20 years. Two mutually exclusive building designs have been drawn up by an architectural firm. Use the modified benefit cost ratio method and a MARR of 10% per year to determine which alternative should be recommended to the city council. Design A (x1000$) Design B (x1000$) Cost of building including cost of the land 1,048 1,315 Resale value...
A city is considering buying a piece of land for $500.000 and construction an office complex...
A city is considering buying a piece of land for $500.000 and construction an office complex on it. Their planning horizon is 20 years. Two mutually exclusive building designs have been drawn up by an architectural firm. Use the modified benefit cost ratio method and a MARR of 10% per year to determine which alternative should be recommended to the city council. Design A (x1000$) Design B (x1000$) Cost of building including cost of the land 1,107 1,306 Resale value...
A city is considering buying a piece of land for $500.000 and construction an office complex...
A city is considering buying a piece of land for $500.000 and construction an office complex on it. Their planning horizon is 20 years. Two mutually exclusive building designs have been drawn up by an architectural firm. Use the modified benefit cost ratio method and a MARR of 10% per year to determine which alternative should be recommended to the city council. Design A (x1000$) Design B (x1000$) Cost of building including cost of the land 1,192 1,320 Resale value...
A company is considering the purchase of a major piece of equipment for its manufacturing plant....
A company is considering the purchase of a major piece of equipment for its manufacturing plant. The project would cost $22m in initial investment and would result in cost savings, before tax, of $3.25m per year for five years. The equipment could be sold for $4.5m at the end of the five years. The equipment would also result in an increase in NWC of $500,000, which will be recovered at the end of the project. The company’s CCA rate is...
A company is considering the purchase of a major piece of equipment for its manufacturing plant....
A company is considering the purchase of a major piece of equipment for its manufacturing plant. The project would cost $22m in initial investment and would result in cost savings, before tax, of $3.25m per year for five years. The equipment could be sold for $4.5m at the end of the five years. The equipment would also result in an increase in NWC of $500,000, which will be recovered at the end of the project. The company’s CCA rate is...
Suppose that you hold a piece of land in the City of London that you may...
Suppose that you hold a piece of land in the City of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that, if the British economy booms in the future, the land will be worth £10,000 and one British pound will be worth $1.36. If the British economy slows down, on the other hand, the land will be worth less, i.e., £9,000, but the...
A French citizen holds a piece of land in the city of London that he wants...
A French citizen holds a piece of land in the city of London that he wants to sell in one year. If the British economy booms in the future, the land will be worth £2,000 and one British pound will be worth of €2.5. If the British economy slows down, the land will be worth of £1,500, and the pound will be worth of €2. He estimates that the British economy will experience a boom with a 60% probability and...
Suppose that you hold a piece of land in the City of London that you may...
Suppose that you hold a piece of land in the City of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that, if the British economy booms in the future, the land will be worth £2,000 and one British pound will be worth $1.40. If the British economy slows down, on the other hand, the land will be worth less, i.e., £1,500, but the...
Suppose that you hold a piece of land in the City of London that you may...
Suppose that you hold a piece of land in the City of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that, if the British economy booms in the future, the land will be worth £2,000 and one British pound will be worth $1.40. If the British economy slows down, on the other hand, the land will be worth less, i.e., £1,500, but the...
Hightech Plc is considering whether or not to go ahead with the production of an innovative...
Hightech Plc is considering whether or not to go ahead with the production of an innovative product. The project (called ‘Project A’) requires an initial investment (at time 0) of £10 million, while the company expects the future cash flows to depend on market demand. If demand is high, starting from next year (time 1) the project will produce a perpetual cash flow of £800,000. In case of low demand, the perpetual cash flow will amount to just £300,000. The...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT