FINANCE FOR BUSINESS

Finance for Business



Finance for Business

Question (a): Estimate the Net Present Value for the above project showing all necessary calculation.

Initial Investment

Franchise Cost

£ 300,000

Alarm Systems Cost

£ 150,000

Working Capital Investment

£ 200,000

Land and Production Facilities

£ 300,000

Total Initial Investment

£ 950,000

Financing Required

£ 650,000

Interest Rate

15%

Annual Interest Expense

£ 97,500

Cost of goods sold for the project is as follows.

Materials £ 80

per unit

Direct Labour £ 80

per unit

Allocated Overheads £ 100

per unit

Total Variable Cost

£ 260

per unit

Fixed Cost

£ 80,000

A research report commissioned from Monty Partners at a cost of £100,000 suggests Castle plc will be able to sell 2,000 units per annum for ten years at a unit cost of £400 each.

Sales Price

£ 400

per unit

Units Sold

2000

units per year

Based on the above presented data, net income for the Castle Plc investment project in producing domestic security alarms for the UK market through a franchising arrangement is as follows.

Year

Sales

COGS

Gross Profit

Advertising Expense

Interest Expense

Net Income

1

£ 800,000 £ 600,000 £ 200,000 £ 100,000 £ 97,500 £ 2,500

2

£ 800,000 £ 600,000 £ 200,000 £ 100,000 £ 97,500 £ 2,500

3

£ 800,000 £ 600,000 £ 200,000 £ 100,000 £ 97,500 £ 2,500

4

£ 800,000 £ 600,000 £ 200,000 £ 100,000 £ 97,500 £ 2,500

5

£ 800,000 £ 600,000 £ 200,000 £ 100,000 £ 97,500 £ 2,500

6

£ 800,000 £ 600,000 £ 200,000 £ 100,000 £ 97,500 £ 2,500

7

£ 800,000 £ 600,000 £ 200,000 £ 100,000 £ 97,500 £ 2,500

8

£ 800,000 £ 600,000 £ 200,000 £ 100,000 £ 97,500 £ 2,500

9

£ 800,000 £ 600,000 £ 200,000 £ 100,000 £ 97,500 £ 2,500

10

£ 800,000 £ 600,000 £ 200,000 £ 100,000 £ 97,500 £ 2,500

Cash flow based on the above results is as follows.

Cash Flow from Year

Year 0

Year 1-9

Year 10

Sales

 

£ 800,000 £ 600,000

Cost of Goods Sold

 

£ 600,000 £ 200,000

Advertising Expense

£ 100,000 £ 100,000

 

Interest Expense

 

£ 97,500 £ 2,500

Initial Investment

£ 950,000

 

 

Salvage Value

 

 

£ 1,000,000

Working Capital

 

 

£ 200,000

Net Cash flow

-£ 1,050,000 £ 2,500 £ 1,597,500

Assuming a discount rate of 8%, project NPV is as follows.

Year

Cash Flow

DF

DCF

0

-£ 1,050,000.00

1.0000

(1,050,000)

1

£ 2,500

0.9259

£ 2,315

2

£ 2,500

0.8573

£ 2,143

3

£ 2,500

0.7938

£ 1,985

4

£ 2,500

0.7350

£ 1,838

5

£ 2,500

0.6806

£ 1,701

6

£ 2,500

0.6302

£ 1,575

7

£ 2,500

0.5835

£ 1,459

8

£ 2,500

0.5403

£ 1,351

9

£ 2,500

0.5002

£ 1,251

10

£ 1,597,500

0.4632

£ 739,952

 

 

NPV

£ (294,431)

Since NPV of the project is negative, therefore Castle Plc should not accept the project in order to save its investment because it can earn more by investing in other funds.

Question (b): Estimate and comment on the Internal Rate of Return, the Profitability Index and the Payback for the above project.

Year

Cash Flow

DF

DCF

0

-£ 1,050,000.00

1.0000

(1,050,000)

1

£ 2,500

0.9259

£ 2,315

2

£ 2,500 ...