Additional Problems

Investment Appraisal

Question 1

The management of Castle Enterprises Ltd are receiving the company’s capital investment proposals for the coming year, and have so far received three project proposals, the details of which are given below. The company’s opportunity cost of capital is 12% pa.

Project A will incur initial capital costs of £32,000 and expected to earn the following net cash inflows:

1st Year £10,000
2nd Year £13,000
3rd Year £14,000
4th Year £10,000

The capital equipment purchased at the start of the project can be resold for £6,000 at the end of the fourth year. No working capital is needed.

Project B would involve an initial outlay of £40,000 on capital equipment and £15,000 on working capital. The annual net cash inflows from the project are estimated as follows:

| | |
|1st Year |£20,000 |
|2nd Year |£17,000 |
|3rd Year | £8,000 |

At the end of the third year, the working capital investment should be recovered, and the equipment would be sold for £3,000.

Project C requires an investment outlay of £50,000 on equipment and £10,000 on working capital. The investment in working capital has to be increased to £12,000 as from the second year. Annual net cash flows would be £15,000 per annum for six years, at the end of which only the investment in working capital would be recovered.

Required:

A) Compute the NPV of each project, and determine which one should be undertaken by the company, under each of the following scenarios:

(i) The three projects are independent (ii) The projects are mutually exclusive.

B) Calculate the payback period of each project and discuss the significance of this