Question

ABC Ltd is considering the establishment of a new branch in a new shopping centre. The company has been offered a five-year lease by the shopping centre. You have been provided with the following information:

(i) The new branch would require an initial investment of $70,000 for machinery, depreciated at 20% per annum on a straight-line basis. After 5 years the machinery would have a salvage value of $6,000.

(ii) A computer would be required to connect to the company’s central system. This would cost $3,000 and be depreciated over 3 years on a straight-line basis. The computer would have no value at the end of 5 years.

(iii) Sales are projected to be $250,000 per annum.

(iv) Recurring costs of the new branch would be:

Staffing $90,000 per annum.

Rent (payable in advance) $48,000 per annum.

Light and power $18,000 per annum.

Inventories (fabric, thread, small tools etc.) $12,000 per annum.

A proportion of head office costs amounting to $10,000 per annum.

(v) Last year the company had carried out a market research which suggested that the new branch would be viable and this research cost was $20,000.

(vi) The company pays tax at 30% and its after-tax cost of capital is 15% per annum.

(vii) The company’s bank has advised that it would charge 10% per annum for a five-year loan to fund the set-up of the new branch. Available earnings are not enough to fund the project. The company would borrow the balance amounting to $50,000 from the bank.

Prepare the cash flow table (which incorporates taxes and includes initial investment, operating and terminal cash flows) for the project using the information given above. Calculate the net present value (NPV) payback period for the project. Should ABC Ltd go ahead with the new branch?

Answer 1