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

Rucas Plc
NPV Calculation
All amount sin currency Aira (AR)		Year 1	Year 2	Year 3	Year 4
Equipment Cost	3,500,000
Depreciation @20% reducing balance		700,000	560,000	448,000	358,400
Total Depreciation	2,066,400
Book Value after 4 Years	1,433,600
Resale value	1,250,000
There is no capital gain so no tax appliable on resale

Sales details
Units sold with 3% annual increase		3,000	3,090	3,183	3,278
Unit price with 6% annual inflation		950	1,007	1,067	1,131
Sales Revenue		2,850,000	3,111,630	3,397,278	3,709,148
Working capital @10% of sales		285,000	311,163	339,728	370,915
Increase in WC over prev year	285,000	26,163	28,565	31,187	(370,915)

	Cash flow details	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
	Initial Investment
	Equiment cost	(3,500,000)
	Net Working Capital Investment	(285,000)	(26,163)	(28,565)	(31,187)
a	Total Initial Investment + WC Investment	(3,785,000)	(26,163)	(28,565)	(31,187)
	Cash flow from operations
	Sales Revenue		2,850,000	3,111,630	3,397,278	3,709,148
	Less Cost of Manufacturing with 6% annual inflation		1,710,000	1,978,997	2,290,309	2,650,593
	Less Fixed cost with 6% annual inflation		60,000	63,600	67,416	71,461
	Depreciation		700,000	560,000	448,000	358,400
	EBT		380,000	509,033	591,553	628,694
	Tax @25%		95,000	127,258	147,888	157,174
	PAT		285,000	381,775	443,665	471,521
	Add back depreciation		700,000	560,000	448,000	358,400
	Add Tax not payable in the cuurent year		95,000	127,258	147,888	157,174
	Less Tax payable in arrear		-	(95,000)	(127,258)	(147,888)	(157,174)
b	Net Cash flow from Operations		1,080,000	974,033	912,295	839,206	(157,174)
	Terminal cash flows
	Equipment salvage value					1,250,000
	Return pf WC					370,915
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