When working capital is recovered at the end of the project it has a different

When working capital is recovered at the end of the

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complicated when inflation is also to be considered. When working capital is recovered at the end of the project it has a different nominal value to the working capital that was invested at the beginning. The nominal value of the investment should be inflated each period to maintain its real value. If the inflation rate is known then the incremental working capital can be included in the NPV appraisal as a relevant cost. The full nominal value of the working capital investment is recovered at the end of the project. If for example a three year project required $500,000 of working capital initially, the inflation rate was 5% and the working capital is recovered at the end of the project. Then the relevant cash flows would be: Year 0 1 2 3 Working capital (500,000) (25,000) (26,250) 551,250
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___________________________________________________________________________________________________________________ Page 9 of 13 IPK COLLEGE 1664, JALAN KULIM, 14202 BUKIT MERTAJAM, PENANG TEL : 012-5203212 / 0125113212 / 04-5512588 Subject: Financial Management (DFM1) Prepared by Susan Lim Email : [email protected] Question Argnil Co is appraising the purchase of a new machine, costing $16 million, to replace an existing machine which is becoming out of date and which has no resale value. The forecast levels of production and sales for the goods produced by the new machine, which has a maximum capacity of 400,000 units per year, are as follows: Year 1 2 3 4 Sales volume (units/year) 350,000 380,000 400,000 400,000 The new machine will incur fixed annual maintenance costs of $145,000 per year. Variable costs are expected to be $3.00 per unit and selling price is expected to be $5.65 per unit. These costs and selling price estimates are in current price terms and do not take account of general inflation, which is forecast to be 4.7% per year. It is expected that the new machine will need replacing in four years' time due to advances in technology. The resale value of the new machine is expected to be $200,000 at that time, in future value terms. The purchase price of the new machine is payable at the start of the fi rst year of the four-year life of the machine. Working capital investment of $150,000 will already exist at the start of the four-year period, due to the operation of the existing machine. This investment in working capital is expected to increase in nomin al terms in line with the general rate of inflation. Argnil Co pays corporation tax one year in arrears at an annual rate of 27% and can claim 25% reducing balance tax-allowable depreciation on the purchase price of the new machine. The company has a real after-tax weighted average cost of capital of 6% and a nominal after-tax weighted average cost of capital of l1%. REQUIRED a) Using a nominal terms net present value approach, evaluate whether purchasing the new machine is financially acceptable. (10 marks) b) Discuss the reasons why investment finance may be limited, even when a company has attractive investment opportunities available to it. (10 marks) (TOTAL 20 MARKS)
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___________________________________________________________________________________________________________________ Page 10 of 13 IPK COLLEGE 1664, JALAN KULIM, 14202 BUKIT MERTAJAM, PENANG TEL : 012-5203212 / 0125113212 / 04-5512588 Subject: Financial Management (DFM1) Prepared by Susan Lim Email : [email protected] Question Uftin Co is a large company which is listed on a major stock market. The company has been
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  • Spring '17
  • JANE KDAL

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