Question

The De Facto Corporation is planning an investment in the consumer electronics market. The corporation already has an established brand recognition in this market, and believes it can capture 5% of the whole market. Table 1 sets out data on the relevant consumer electronics market.

Table 1: Consumer electronics market (numbers in millions) Annual sales revenues £100,000 Annual costs (variable) £50,000 Annual growth in sales/costs 3% Beta of sales and cost cash flows 1.5

Table 2 sets out data on De Facto Co’s investment project. Table 2: De Facto Co’s investment project Investment cost in year 0 £5.9bn Annual fixed costs £1bn Annual sales revenues 4.5% of total market Annual variable cost 4% of total market Working capital 20% of next year’s sales Duration 10 years The risk-free interest rate is 3% and the average return on the market index is 7%.

a. What is the relevant cost of capital for De Facto Co’s investment appraisal analysis?

b. What is the present value of De Facto Co’s future sales revenues?

c. What is the present value of De Facto Co’s future variable and fixed costs?

d. What is the net present value of De Facto Co’s working capital investment?

e. What is the net present value of De Facto Co’s total investment in the consumer electronics market?

f. Why do you think that De Facto Co’s sales revenues are 4.5% of the total market but only 4% of the total variable cost?

Answer 1

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