Question 5

Kien Sneakers has identified two possible three locations (Hoxton or Hounslow) for its new warehouse. The finance manager has estimated the upfront costs and associated cashflows (as shown below).

	Hoxton	Hounslow
Year 0	(25,000)	(50,000)
Year 1	15,000	(5,000)
Year 2	15,000	5,000
Year 3	7,500	10,000
Year 4	5,500	15,000
Year 5	3,000	20,000
Year 6	2,000	30,000

Required:

a)Calculate the payback period for each relocation option and suggest which of them (if any) is worthwhile if it is the companys policy not to accept any option with a payback period longer than 4 years.

Kien Sneakers now asks you to undertake a financial appraisal of the two location options. The planning period for the appraisal is six years; assume no salvage value at the end of that period. The finance manager believes that Hoxton is a less risky choice than Hounslow. On this basis, he believes that they should use a discount rate of 9% for Hoxton and 10% for Hounslow.

Required:

a)Calculate the Net Present Value (NPV) for each location. Which location would you advise according to this technique? Explain your reasoning.

b)Calculate the Internal Rate of Return (IRR) for each location. Show your workings.

c)Write a brief report (of about 150 words) for Kien Sneakers management team advising the company on which option it should choose. Give reasons for your decision and identify any limitations of the methods applied.