Question 1 Henry and Harriet trading as HH Limited operate clothing concessions in several large department...
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Question 1 Henry and Harriet trading as HH Limited operate clothing concessions in several large department stores. A major city store will shortly open its first provincial branch and HH Limited is currently negotiating terms for an in-store concession. There will be a substantial initial outlay on shop-fitting which the company must recoup within three years; after that time, under the terms of the draft agreement with the department store, HH Limited will be required to completely refurbish their space. The company has had a great deal of experience in this type of shop-fitting and is able to estimate the costs involved to a high degree of accuracy. The Directors are, therefore, confident in their estimate of 100,000 for shop fitting. There will be additional advertising expenditure of 10,000 in the first year (to be treated as a cash outflow arising in year 1). However, the cash inflows arising from the project are less easy to estimate. The directors have prepared two sets of figures - one optimistic and one pessimistic. They wish to appraise both sets of figures in order to be able to assess the impact of the worse-case scenario. Their net cash inflow projections are as follows: Year Optimistic Scenario () Pessimistic Scenario () 1 50,000 25,000 2 54,000 29,000 3 58,000 33,000 4 62,000 30,000 The company is currently using a discount rate of 8% Required: (a) Calculate the Payback for both scenarios (b) Calculate the Net Present Value (NPV) of both scenarios (4 marks) (10 marks) (c) The Finance Manager is keen to show for the Pessimistic scenario project the use of IRR and is aware that using a discount factor of 5% will generate positive NPV of 6,022. Calculate the IRR for this project. (8 marks) (d) Advise the Directors whether they should proceed on the basis that there is no Capital Rationing. (3 marks) [Total 25 Marks] Page 2 of 8 Question 1 Henry and Harriet trading as HH Limited operate clothing concessions in several large department stores. A major city store will shortly open its first provincial branch and HH Limited is currently negotiating terms for an in-store concession. There will be a substantial initial outlay on shop-fitting which the company must recoup within three years; after that time, under the terms of the draft agreement with the department store, HH Limited will be required to completely refurbish their space. The company has had a great deal of experience in this type of shop-fitting and is able to estimate the costs involved to a high degree of accuracy. The Directors are, therefore, confident in their estimate of 100,000 for shop fitting. There will be additional advertising expenditure of 10,000 in the first year (to be treated as a cash outflow arising in year 1). However, the cash inflows arising from the project are less easy to estimate. The directors have prepared two sets of figures - one optimistic and one pessimistic. They wish to appraise both sets of figures in order to be able to assess the impact of the worse-case scenario. Their net cash inflow projections are as follows: Year Optimistic Scenario () Pessimistic Scenario () 1 50,000 25,000 2 54,000 29,000 3 58,000 33,000 4 62,000 30,000 The company is currently using a discount rate of 8% Required: (a) Calculate the Payback for both scenarios (b) Calculate the Net Present Value (NPV) of both scenarios (4 marks) (10 marks) (c) The Finance Manager is keen to show for the Pessimistic scenario project the use of IRR and is aware that using a discount factor of 5% will generate positive NPV of 6,022. Calculate the IRR for this project. (8 marks) (d) Advise the Directors whether they should proceed on the basis that there is no Capital Rationing. (3 marks) [Total 25 Marks] Page 2 of 8
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