Mercia plc owns two acres of derelict land near to the centre of a major UK...
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Mercia plc owns two acres of derelict land near to the centre of a major UK city. The firm has received an invoice for £50,000 from consultants who were given the task of analysis, investigation and design of some project proposals for using the land. The consultants outline the two best proposals to a meeting of the board of Mercia. Proposal 1 is to spend £150,000 levelling the site and then constructing a six-level car park at an additional cost of £1,600,000. The earthmoving firm will be paid £150,000 on the start date. and the construction firm will be paid £1.4m on the start date, with the balance payable 24 months later. It is expected that the car park will be fully operational as from the completion date (365 days after the earthmovers first begin). The annual income from ticket sales will be £600,000 to an infinite horizon. Operational costs (attendants, security, power, etc.) will be £100,000 per annum. The consultants have also apportioned £60,000 of Mercia's central overhead costs (created by the London-based head office and the executive jet) to this project. The consultants present their analysis in terms of a commonly used measure of project viability, that of payback. This investment idea is not original; Mercia investigated a similar project two years ago and discovered that there are some costs which have been ignored by the consultants. First, the local council will require a payment of £100,000 one year after the completion of the construction for its inspection services and a trading and environmental impact licence. Second, senior manage- ment will have to leave aside work on other projects, resulting in delays and reduced income from these projects amounting to £50,000 per year once the car park is operational. Also, the proposal is subject to depreciation of one-fiftieth (1/50) of the earthmoving and construction costs each year. Proposal 2 is for a health club. An experienced company will, for a total cost of £9m payable at the start of the project, design and construct the buildings and supply all the equipment. It will be ready for Mercia's use one year after construction begins. Revenue from customers will be £5m per annum and operating costs will be £4m per annum. The consultants allocate £70,000 of central general head office overhead costs for each year from the start. After two years of operating the health club Mercia will sell it for a total of £11m. Information not considered by the consultants for Proposal 2 The £9m investment includes £5m in buildings not subject to depreciation. It also includes £4m in equipment, 10 per cent of which to be replaced each year. This has not been included in the operating costs. A new executive will be needed to oversee the project from the start of the project - costing £100,000 per annum. The consultants recommend that the board of Mercia accept the second proposal and reject the first. Assume - If the site was sold with no further work carried out it would fetch £100,000. - No inflation or tax. - The cost of capital for Mercia is 10 per cent. - It can be assumed, for simplicity of analysis, that all cash flows occur at year ends except those occurring at the start of the project. Required a Calculate the net present value of each proposal. State whether you would recommend Proposal 1 or 2. b Calculate the internal rate of return for each proposed project. Mercia plc owns two acres of derelict land near to the centre of a major UK city. The firm has received an invoice for £50,000 from consultants who were given the task of analysis, investigation and design of some project proposals for using the land. The consultants outline the two best proposals to a meeting of the board of Mercia. Proposal 1 is to spend £150,000 levelling the site and then constructing a six-level car park at an additional cost of £1,600,000. The earthmoving firm will be paid £150,000 on the start date. and the construction firm will be paid £1.4m on the start date, with the balance payable 24 months later. It is expected that the car park will be fully operational as from the completion date (365 days after the earthmovers first begin). The annual income from ticket sales will be £600,000 to an infinite horizon. Operational costs (attendants, security, power, etc.) will be £100,000 per annum. The consultants have also apportioned £60,000 of Mercia's central overhead costs (created by the London-based head office and the executive jet) to this project. The consultants present their analysis in terms of a commonly used measure of project viability, that of payback. This investment idea is not original; Mercia investigated a similar project two years ago and discovered that there are some costs which have been ignored by the consultants. First, the local council will require a payment of £100,000 one year after the completion of the construction for its inspection services and a trading and environmental impact licence. Second, senior manage- ment will have to leave aside work on other projects, resulting in delays and reduced income from these projects amounting to £50,000 per year once the car park is operational. Also, the proposal is subject to depreciation of one-fiftieth (1/50) of the earthmoving and construction costs each year. Proposal 2 is for a health club. An experienced company will, for a total cost of £9m payable at the start of the project, design and construct the buildings and supply all the equipment. It will be ready for Mercia's use one year after construction begins. Revenue from customers will be £5m per annum and operating costs will be £4m per annum. The consultants allocate £70,000 of central general head office overhead costs for each year from the start. After two years of operating the health club Mercia will sell it for a total of £11m. Information not considered by the consultants for Proposal 2 The £9m investment includes £5m in buildings not subject to depreciation. It also includes £4m in equipment, 10 per cent of which to be replaced each year. This has not been included in the operating costs. A new executive will be needed to oversee the project from the start of the project - costing £100,000 per annum. The consultants recommend that the board of Mercia accept the second proposal and reject the first. Assume - If the site was sold with no further work carried out it would fetch £100,000. - No inflation or tax. - The cost of capital for Mercia is 10 per cent. - It can be assumed, for simplicity of analysis, that all cash flows occur at year ends except those occurring at the start of the project. Required a Calculate the net present value of each proposal. State whether you would recommend Proposal 1 or 2. b Calculate the internal rate of return for each proposed project.
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Answer rating: 100% (QA)
a Proposal 1 NPV 50000 1600000111 150000110 1400000111 ... View the full answer
Related Book For
Business Math
ISBN: 978-0133011203
10th edition
Authors: Cheryl Cleaves, Margie Hobbs, Jeffrey Noble
Posted Date:
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