You are a member of a group of financial consultants who have been called in to help Green Energy Plc., who have recently taken over a smaller, unquoted competitor, South Westerly Turbines Ltd. Green Energy Plc. have been checking over various documents at South Westerly Turbine’s head office, including a number of recent project appraisals carried out by South Westerly Turbine.

Among the appraisals a recently rejected project has been found which involves an outlay on equipment of £6.8 million. The analysis relating to the project is reproduced below. The project was rejected on the grounds that it failed to return South Westerly Turbine’s target accounting rate of return on investment of 18%.

Green Energy Plc. would like you to analyze the project more closely as their accountant has already found several errors.

South Westerly Turbine’s appraisal of a proposed project to upgrade wind turbines through

investment in new equipment (000):

		0	1	2	3	4
Increase in sales		-9,000	7,000	7,500	8,500	8,500
Materials			-2,400	-2,600	-2,800	-2,800
Direct labor			-2000	-2000	-2000	-2000
Overheads			-600	-600	-600	-600
Interest			-400	-400	-400	-400
Profit pre tax			1,100	1,900	2,700	2,700
Tax @ 33%			363	627	891	891
Post tax profit			737	1273	1809	1809

Immediate Outlay at Year 0 (in £000’s)

Working Capital             (1,200)

Equipment                    (6,800)

Market Research           (1,000)

                                    (9,000)

Rate of return: (£000)   Average profit               =          £1,407 =          15.63%

                                    Investment                               £9,000

You also discover the following information:

1). A 25% writing-down allowance on a reducing balance basis is available for this new investment. South Westerly Turbine’s profits are sufficient to utilize this allowance throughout the project.

2). Corporation tax is paid yearly in arrears.

3). Approximately half of the overhead charge consists of absorption of existing overhead costs.

4). The market research was undertaken previously to explore this and another proposal and has already been paid.

5). Green Energy Plc.’s required rate of return on new projects is 14%, after tax.

6). The equipment has a (pre-tax) scrap value of £900,000.

(a) Prepare a new investment appraisal for Green Energy Plc. by calculating the post-tax net present value (NPV) of the proposed project rejected by South Westerly Turbines Ltd. You should recommend whether or not the project should be undertaken. Clearly state any assumptions made.

Answer rating: 100% (QA)

in 000s Depn Table Workings Year Depnat 25prev BV BV ATCF on sale 0 6800 Book value at end yr4 2152 ... View the full answer