The Deli Company is planning an investment in the consumer electronics market. The company already has an
Question:
The Deli Company is planning an investment in the consumer electronics market. The company already has an established brand recognition in this market, and believes it can capture 5% of the whole market. Table 1 sets out data on the relevant consumer electronics market.
Table 1: Consumer electronics market (numbers in millions)
Annual sales revenues | £100,000 |
Annual costs (variable) | £50,000 |
Annual growth in sales/costs | 3% |
Beta of sales and cost cash flows | 1.5 |
Table 2: Deli's investment project
Investment cost in year 0 | £5.9bn |
Annual fixed costs | £1bn |
Annual sales revenues | 4.5% of total market |
Annual variable cost | 4% of total market |
Working capital | 20% of next year’s sales |
Duration | 10 years |
The risk-free interest rate is 3% and the average return on the market index is 7%.
1. What is the relevant cost of capital for Deli’s investment appraisal analysis?
2. What is the present value of Deli’s future variable and fixed costs?
3. What is the net present value of Deli’s working capital investment?
4. What is the present value of Deli’s future sales revenues?
5. What is the net present value of Deli’s total investment in the consumer electronics market?
6. Why do you think that Deli’s sales revenues are 4.5% of the total market but only 4% of the total variable cost?
Accounting
ISBN: 978-0324401844
22nd Edition
Authors: Carl S. Warren, James M. Reeve, Jonathan E. Duchac