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BQK Co, a house-building company, plans to build 100 houses on a development site over the next four years. The purchase cost of the development site is $4,000,000, payable at the start of the first year of construction. Two types of house will be built, with annual sales of each house expected to be as follows:

Year 1 2 3 4
Number of small houses sold 15 20 15 5
Number of large houses sold 7 8 15 15

 

Houses are built in the year of sale. Each customer finances the purchase of a home by taking out a long-term personal loan from their bank. Financial information relating to each type of house is as follows:

     Small house     Large house
Selling price $200,000 $350,000
Variable cost of construction $100,000 $200,000

 

Selling prices and variable cost of construction are in current price terms, before allowing for selling price inflation of 3% per year and variable cost of construction inflation of 4.5% per year.

Fixed infrastructure costs of $1,500,000 per year in current price terms would be incurred. These would not relate to any specific house, but would be for the provision of new roads, gardens, drainage and utilities. Infrastructure cost inflation is expected to be 2% per year. 

BQK Co pays profit tax one year in arrears at an annual rate of 30%. The company can claim tax allowable depreciation on the purchase cost of the development site on a straight-line basis over the four years of construction. 

BQK Co has a real after-tax cost of capital of 9% per year and a nominal after-tax cost of capital of 12% per year. New investments are required by the company to have a before-tax return on capital employed (accounting rate of return) on an average investment basis of 20% per year. 

Requirements:

a

Calculate the net present value of the proposed investment and ARR and comment on its financial acceptability. Work to the nearest $1,000.

Marks: 13
b

Discuss the effect of a substantial rise in interest rates on the financing cost of BQK Co and its customers, and on the capital investment appraisal decision-making process of BQK Co.

Marks: 7

Answers submitted

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Rakhi Gupta's picture
Rakhi Gupta
10/31/2020 - 00:21
a
9962
13
Rakhi Gupta's picture
Rakhi Gupta
10/31/2020 - 01:03
b
9964
7
Rakhi Gupta's picture
Rakhi Gupta
10/21/2020 - 10:26
a
9886
13
Rakhi Gupta's picture
Rakhi Gupta
10/21/2020 - 10:52
b
9888
7
Apurba nandy's picture
Apurba nandy
03/01/2020 - 21:23
a
8902
13
Apurba nandy's picture
Apurba nandy
12/03/2019 - 12:27
a
8356
13
Apurba nandy's picture
Apurba nandy
12/03/2019 - 12:18
a
6060
13
Tanbirul Kabir Tanbir's picture
Tanbirul Kabir ...
11/06/2019 - 19:32
a
7880
11 / 13
Masum Billah's picture
Masum Billah
11/05/2019 - 22:52
a
7872
11 / 13
Tanzeer UL Alaam's picture
Tanzeer UL Alaam
09/20/2019 - 14:07
a
7434
10 / 13
Abhro Gourab Das's picture
Abhro Gourab Das
09/02/2019 - 20:16
a
7170
13
Abhro Gourab Das's picture
Abhro Gourab Das
09/02/2019 - 20:17
b
7174
7
Subrata Banik's picture
Subrata Banik
09/02/2019 - 17:40
a
7172
13
Siti Izzati Iskandar
08/24/2019 - 17:15
a
7020
13
Sohel Miah's picture
Sohel Miah
08/05/2019 - 00:32
a
6722
13
Md Hasan Uz Zaman's picture
Md Hasan Uz Zaman
05/28/2019 - 00:44
a
6046
13
Md Hasan Uz Zaman's picture
Md Hasan Uz Zaman
05/28/2019 - 00:37
a
6454
13