Lecture 3 Seminar Questions(1).docx

Question 1

Balestra Limited, a manufacturer of baths and bathroom fittings, is considering moving into production of luxury showers. Management consultants have undertaken a feasibility study at a cost of £9,000 and they have forecast the following cash flows for the project:                                                        

                                                                                                                                                          £000

Start (Year 0)                            New Machinery                                                                      (258)

Year 1                             Cash inflow before depreciation                                                        55

Year 2                             Cash inflow before depreciation                                           85

Year 3                             Cash inflow before depreciation                                           115

Year 4                                          Cash inflow before depreciation                                          80

Year 5                             Cash inflow before depreciation                                           40

                                                   Proceeds from disposal of Machinery                                             28

Assume that all cash flows arise at the end of the year to which they relate. The machinery would be sold at the end of 5 years. The average annual accounting profit is £29 000.

                                                            Yr0                  Yr1                  Yr2                  Yr3                   Yr4     Yr5

Discount Rate @ 15%              1.00                  0.8    0.76   0.66    0.57   0.50

Required:

(a) Calculate the Payback Period for the shower project

(b) Calculate the Accounting Rate of Return for the project

(c) Calculate the Net Present Value for the project, using a discount rate of 15% - the rate that Balestra Limited usually requires from new projects

(d) Advise Balestra Limited as to whether it should consider proceeding with the production of these showers.

Question 2

New Machine - Complete the budget for the New Machine; and then calculate the Payback Period and NPV of the project:                                                                                                 

The New Machine will cost £7,000,000 to purchase                                                                                                 

The New Machine will produce 8,000 units a year, all of which will be sold immediately after completion                                                                                                 

The Sales Price per unit is fixed at £850, however due to perceived obsolescence the price will drop at the end of year two to £600                                                                                                 

Average Purchases cost per unit is £400 and this is expected to increase by 10% each year                                                                                                 

The Discount Rate for investment appraisal is 5%                                                                                                 

                            Year 0                            Year 1                            Year 2                            Year 3                            Year 4                           

Revenues                                                                                                 

Purchase Costs                                                                                                 

Cost of Sales                                                                                                 

Cash Flows                                                                                                 

Cumulative                                                                                                   

Sales Price / Unit                                                                                                 

Purchase Price / Unit                                                                                                 

Discount Table                                                                                                  

Year                                          0              1                            2                            3                            4                             5

Discount Rate at 5%              1              0.952               0.907                             0.864                             0.823                    0.784             

Discount Rate @ 10%1              0.909               0.826                0.751                             0.683                    0.621