An engineering company in the south-east of the country is currently considering investig in new plant...

   

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An engineering company in the south-east of the country is currently considering investig in new plant in order to enable expansion of its limited product range. The businesse incurred expenditure of €34,000 over the past three years researching and developing products. Following this research, the company has identified two possible options fo investment and these have been put forward for appraisal. The following data is availab for each project: Cost (immediate outlay) Expected annual net profit (loss): Year 1 Year 2 Year 3 Estimated residual value of the plant (0 The net present value. (i) The approximate internal rate of return. (ii) The payback period. Project A € 163,000 Solution: (a) P.T.O. (b) (c) (6,000) 45,000 86,000 13,000 Along with the initial cost of the new plant the business would have to invest a further €45,000 in working capital in either project which can be recouped at the end of the project. Both projects would incur marketing costs of €16,000 per annum. The business has an estimated cost of capital of 10% and uses the straight-line method of depreciation for all non-current (fixed) assets when calculating net profit. The business has sufficient funds to meet all capital expenditure requirements. Ignore taxation. Assume it is now November 30th Year 0. (a) Calculate for each project: Project B € 184,000 26,000 57,000 42,000 4,000 (b) State which, if any, of the two projects the directors of the engineering company should accept and the reasons why. (c) State, in general terms, which method of investment appraisal you consider to be most appropriate for evaluating investment projects, and why. & Eng (Hons) in Mech. & Man. Eng. (Yr 4) NPV (Project A) Net Profit (Loss) Depreciation Capital Cost Working Capital Residual Value Net Cash Flows 10% Disc. Factor Present Value 15% Disc. Factor Present Value NPV (Project B) Net Profit (Loss) Depreciation Capital Cost Working Capital Residual Value Net Cash Flows 10% Disc. Factor Present Value 15% Disc. Factor Present Value Year 0 € Year 0 € Year 1 € Year 1 € Year 2 € Manufacturing Facilities NPV NPV Year 2 € NPV NPV Year 3 Year 3 € 8. Eng. (Hons) in Mech. & Man. Eng. (Yr 4) IRR (Project A) IRR IRR (Project B) IRR PP (Project A) Time PP (Project B) Time Net Cash Flow € Net Cash Flow € Cumulative Net Cash Flow Cumulative Net Cash Flow € An engineering company in the south-east of the country is currently considering investig in new plant in order to enable expansion of its limited product range. The businesse incurred expenditure of €34,000 over the past three years researching and developing products. Following this research, the company has identified two possible options fo investment and these have been put forward for appraisal. The following data is availab for each project: Cost (immediate outlay) Expected annual net profit (loss): Year 1 Year 2 Year 3 Estimated residual value of the plant (0 The net present value. (i) The approximate internal rate of return. (ii) The payback period. Project A € 163,000 Solution: (a) P.T.O. (b) (c) (6,000) 45,000 86,000 13,000 Along with the initial cost of the new plant the business would have to invest a further €45,000 in working capital in either project which can be recouped at the end of the project. Both projects would incur marketing costs of €16,000 per annum. The business has an estimated cost of capital of 10% and uses the straight-line method of depreciation for all non-current (fixed) assets when calculating net profit. The business has sufficient funds to meet all capital expenditure requirements. Ignore taxation. Assume it is now November 30th Year 0. (a) Calculate for each project: Project B € 184,000 26,000 57,000 42,000 4,000 (b) State which, if any, of the two projects the directors of the engineering company should accept and the reasons why. (c) State, in general terms, which method of investment appraisal you consider to be most appropriate for evaluating investment projects, and why. & Eng (Hons) in Mech. & Man. Eng. (Yr 4) NPV (Project A) Net Profit (Loss) Depreciation Capital Cost Working Capital Residual Value Net Cash Flows 10% Disc. Factor Present Value 15% Disc. Factor Present Value NPV (Project B) Net Profit (Loss) Depreciation Capital Cost Working Capital Residual Value Net Cash Flows 10% Disc. Factor Present Value 15% Disc. Factor Present Value Year 0 € Year 0 € Year 1 € Year 1 € Year 2 € Manufacturing Facilities NPV NPV Year 2 € NPV NPV Year 3 Year 3 € 8. Eng. (Hons) in Mech. & Man. Eng. (Yr 4) IRR (Project A) IRR IRR (Project B) IRR PP (Project A) Time PP (Project B) Time Net Cash Flow € Net Cash Flow € Cumulative Net Cash Flow Cumulative Net Cash Flow €

Answer rating: 100% (QA)

a To calculate the net present value NPV approximate internal rate of return IRR and payback period for each project we need to discount the cash flows using the cost of capital and analyze the timing of cash flows Project A Initial Cost 163000 Expected Annual Net Profit Year 1 6000 Year 2 26000 Year 3 13000 Estimated Residual Value 45000 Working Capital 45000 Marketing Costs 16000 per annum Cost of Capital 10 Step 1 Calculate the discounted cash flows for each year Discounted Cash Flow Cash Flow 1 Cost of Capitaln Year 0 Initial Investment 163000 45000 16000 224000 Year 1 6000 45000 16000 1 0101 Year 2 26000 45000 16000 1 0102 Year 3 13000 45000 16000 45000 1 0103 Step 2 Calculate the net present value NPV NPV Sum of Discounted Cash Flows Initial Investment For Project A calculate the NPV using the above calculations To approximate the internal rate of return IRR we can use the trial and error method or financial softwareexcel functions to find the discount rate that makes the NPV equal to zero The payback period is the time it takes for the initial investment to be recovered Calculate the cumulative cash flows and determine the year when the cumulative cash flow ... View the full answer