Roundabout Ltd has undertaken market research at a cost of 37,000 to assess the feasibility of two
Question:
Roundabout Ltd has undertaken market research at a cost of £37,000 to assess the feasibility of two mutually exclusive investment project.
Project 1 will have an initial (i.e. Year Zero) capital investment of £1,400,000 and has an expected life cycle of 3 years.
The forecast future cash flows of Project A are as follows:
At the end of the three years, the project is expected to have resale value of £200,000 (this figure includes the effect of inflation).
Project 2 will have an initial (I.e. Year Zero) capital investment of £2,000,000 and has an expected life cycle of 5 years.
The forecast future cash flows (received at the end of each year) of Project B are as follows:
At the end of the five years, the project is not expected to have any resale value and will cost £300,000 (this figure includes the effect of inflation) to be disposed of legally. This cost is allowed to be deducted from taxable profit.
For both projects, all the forecast cash flows above should be assumed to occur at the end of the year. They have also been provided in current terms, i.e., the values are based in year zero. Both the forecast revenues and costs are expected to inflate by the general rate of inflation of 4% per year from Year 1 onwards.
For both projects, the initial capital expenditure would attract capital allowances of 25% on a reducing balance basis from Year 1 onwards. Any scrap proceeds or scrap costs should be factored into a balancing allowance or balancing charge.
Roundabout Ltd pays tax on profits at an annual rate of 21% per annum, with tax paid one year in arrears. The company has a nominal (i.e. inflation-inclusive) cost of capital of 12% per year.
Required:
(a) Calculate the net present value of both projects and from your results, assess which of the projects (if any) Roundabout Ltd should invest in.
Note: Show figures to the nearest pound.
(b) What other considerations (financial or non-financial) should Roundabout Ltd make when deciding which project (if any) to invest in? NOTE: You do not need to make any calculations to answer this part.
Contemporary Financial Management
ISBN: 9780324289114
10th Edition
Authors: James R Mcguigan, R Charles Moyer, William J Kretlow