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Investment Appraisal Seminar Questions You are expected to answer as many of the questions below as possible before attending your seminar. In the seminar, we will discuss your answers. To get the maximum benefit from the seminars it is very important you engage with the tasks prior to the seminar. 1. Degree plc., is considering investing in a number of potential projects of which they have only 1,000,000 to spend. Using information in the table below, first complete the table and second, identify which combination of projects should Degree plc., undertake? Project PV (in ) Cost (in ) NPV (in ) NPV Rank PI PI Rank 1 535,000 500,000 2 480,000 450,000 3 432,750 400,000 4 300,000 280,000 5 225,225 200,000 6 130,050 100,000 2. Conwy plc., is to replace an aging delivery vehicle and is considering whether to buy a new vehicle or a used vehicle as a replacement. The average annual mileage is 60,000. The relevant estimated costs are as follows: Used Vehicle New Vehicle Initial cost 30,000 80,000 Average annual maintenance costs 15,000 9,000 Fuel costs per mile 80p 60p Expected lifetime 4 years 6 years Conwys relevant cost of capital is 8%. The estimated resale value of the new vehicle is 20,000 after 4 years. Ignore taxation. Calculate the best financial option using: a) Annual equivalents; b) Residual Values 3. Kilkennie plc., manufactures components for the automobile industry. They have just been offered a new four-year contract to supply a component, subject to them meeting certain quality requirements. The production manager is concerned that the current machine, which has been fully depreciated, will not be able to meet the stringent quality controls that will be required because the technology is obsolete, and the machine is unreliable. The company currently spends 50,000 per year to maintain and operate this machine. Assume the machine is sold for 350,000 at the end of year 4. On the basis of the production managers recommendation, management has decided to replace the current machine. It is estimated that the replacement machine will cost 1 million with a four-year useful life. The companys depreciation policy is to use a 25% reducing balance method over the life of the asset. As part of the purchase agreement for the new machine, the suppliers are offering a special maintenance contract costing 10,000 for each of the four years. The following forecasted financial information has been prepared: I. Revenues and costs the estimated annual revenues and costs from the project for the next four years are in the table below: Year Revenues (in ) Costs (in ) 1 800,000 350,000 2 850,000 385,000 3 880,000 410,000 4 920,000 435,000 II. Taxation: (i) Capital allowances the new machine will attract a 20% declining balance writing-down allowance each year. (ii) The company pays corporate tax at a rate of 20% of taxable profit. Assume the company pays corporation tax in the year the profit is generated. III. It is estimated that the machine will be sold for 350,000 at the end of year 4 and thus a balancing charge will be incurred. IV. The company uses an after tax cost of capital of 18% as the discount rate for investments of this risk class. REQUIRED: Taking into account the annual capital allowances for the machine, the annual tax liability and the annual cash flows, evaluate the viability of the four-year contract to supply the motor manufacturer for Kilkennie plc., using NPV analysis. 4. Nova plc., is considering a project which would require an outlay of 1.8m at the outset. The money cash flows receivable from sales will depend on the specific inflation rate for Novas product. This is anticipated to be 6% per annum. Cash outflows consist of three elements: labour, materials, and overheads. Labour costs are expected to increase at 5% per year, materials by 6% and overheads by 4%. Nova plc requires a real rate of return of 12% on projects of this risk class, and anticipates the general rate of inflation to be 4% per annum over the 3-year life of the project. The annual cash flows in present time (Time 0) prices are in the table below: m Inflation Sales 2.4 6% Labour costs 0.4 5% Material costs 0.5 6% Overheads 0.06 4% Calculate the NPV of the project using both methods of adjusting for inflation

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