The Nyx Co assesses the planned $20 million investment for a new product payable at the beginning
Question:
The Nyx Co assesses the planned $20 million investment for a new product payable at the beginning of the first year of operation. The product will be manufactured for four years, at which time it will cease production. The investment project will have a zero terminal value. Financial details on the investment project are as follows:
Year 1 2 3 4
Sales volume (units/year) 440,000 550,000 720,000 400,000
Selling price ($/unit) 26.50 28.50 30.00 26.00
Fixed cost ($/year) 1,100,000 1,121,00 1,155,000 1,200,00
These sales prices are still not adjusted for inflation, which is projected to be 3.5% per annum. The fixed annual costs are indicated in nominal terms above. Variable costs per unit depend on whether there is competition between key component suppliers. The purchasing department has predicted the following:
Competition Strong Moderate Weak
Probability 45% 35% 20%
Variable c/u 10.80 12.00 14.70
The variable costs in this forecast are 4.0 percent per year before taking into account variable cost inflation. Nyx Co can claim a tax depreciation allowable by 25% per year, reducing the balance based on the full investment cost of 20 million dollars and paying corporate tax in arrears by 28% each year. The investment project is scheduled to be financed with an 8% loan issue, which can be reimbursed in ten years time. The Nyx Co has an average nominal after-tax weighted capital cost of 10 percent, the weighted average real after-tax capital cost of 7 percent and equity costs of 11 percent.
Required
(a) Discuss the differences in investment assessment between risk and uncertainty.
(b) Calculate and discuss the net expected present value of the investment project and its financial acceptability and variable cost risks. (c) Critically discuss how risk in the investment assessment process can be considered.
Financial Accounting
ISBN: 978-1259103285
5th Canadian edition
Authors: Robert Libby, Patricia Libby, Daniel Short, George Kanaan, M