Question

The board have approached you to get your opinion of their expansion plan, which includes a chain of factory outlet stores. Below are the figures for the first one that is planned for a central Birmingham location next year.

Company policy dictates that any decision should be based on the results of calculating Net Present Value (NPV) of 3 years cash flows using a cost of capital of 12%, Payback Period (PBP) must be less than 3 years, and the Internal Rate of Return (IRR) of the project should provide a 5% cushion in case of increases in inflation or interest rates.

The investment consists of £2,000,000 for the land, building costs of £3,950,000, and £915,000 for fittings and equipment.

The cash flows in year 1 are expected to be: total sales revenue £14,300,000; the cost of Alpha products sold £3,950,000; Beta stock sold £2,830,000; staff costs £590,000; light & heat £838,000; other overheads £3,212,000. The cash flows for the following years are the same, but are expected to increase by 2% inflation each year.

1.Based on your calculations do you recommend the investment is made and the new outlet store is built?

2.Critically discuss the limitations of the above project appraisal techniques used and any other recommendations to the board.

Answer 1

Dear Reader

The important concepts in this question is to determine IRR and calculation part to calculate present value of cash inflow. Please read answer carefully in respect of above concepts.

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