Question

Coles is evaluating the use of self-checkout technology in all stores. It would have to invest $20,000,000 now and $15,000,000 next year. The company will also need to pay an additional $8,000,000 now in redundancy packages for staff being let go.This project in forecasted to result in 5 years of salary cost savings. The cost savings will be $15,000,000 in the first year and the savings will diminish 20% annually.Coles has 60% of its capital financed through equity costing 8% p.a. and its creditors require a return of 6% p.a.

1. Draw a timeline and set out cash inflows, outflows by year
2. Calculate the required rate of return of this project
3. Using NPV approach to identify if the project should be accepted and why?

Answer 1

a)

The cash flows associated with the project is shown in the following table

To draw the cash flow timeline, we can make use of column chart in excel. To insert the column chart , select the above data and choose insert , charts in excel, select column graph.

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b)

The weighted average cost of capital is calculated as follows

WACC = We re + Wd rd (1-tc) + Wprp

WACC = 0.60 0.08 + 0.40 0.06

Required rate of return of this project = 7.2%

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c)

NPV = $390,181.529

The project should be accepted because the net present value of the project is greater than zero which makes the investment economically viable.