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Project E is a strategically important project which the Board of OAP Co have decided must be undertaken in order for the company to remain competitive, regardless of its financial acceptability. The project has a life of four years. Information relating to the future cash flows of this project are as follows:

Year    1 2 3 4
Sales volume (units)    12,000 13,000 10,000 10,000
Selling price ($/unit)    450 475 500 570
Variable cost ($/unit)    260 280 295 320
Fixed costs ($'000)    750 750 750 750

These forecasts are before taking into account of selling price inflation of 5.0% per year, variable cost inflation of 6.0% per year and fixed cost inflation of 3.5% per year. The fixed costs are incremental fixed costs which are associated with Project E.

Additional fixed cost allocated to this project from head office is $20,000.

The initial investment for Project E is $4,000,000.

At the end of four years, machinery from the project will be sold for scrap with a value of $400,000. Tax allowable depreciation on the initial investment cost of Project E is available on a 25% reducing balance basis and OAP Co pays corporation tax of 28% per year, one year in arrears. A balancing charge or allowance is available at the end of the fourth year of operation.

Based on the investment of $4m and residual value $400,000, straight line depreciation on the project will be $900,000 pa.

OAP co has already spent $50,000 to gather necessary information on the project and do preliminary cash flow projection.

Additional working capital investment in year zero is $567,000. Working capital requirement of the project will vary from year to year depending on the change in the sales revenue. At the end of year 4 (project life) net investment in working capital will be returned. 

The project will be financed by a loan of $4m on which OAP Co. will pay 10% interest pa for four years. 

OAP Co has a nominal after-tax cost of capital of 13% per year. 

Requirements:

a

Calculate the nominal after-tax net present value of Project E and comment on the financial acceptability of this project .

Marks: 14
b

Discuss the reasons why the Board of OAP may decide to limit the funds that are available to finance projects?

Marks: 6

Answers submitted

Created by Ref Marking Action
Tanbirul Kabir Tanbir's picture
Tanbirul Kabir ...
11/06/2020 - 21:54
a
10036
14
Rakhi Gupta's picture
Rakhi Gupta
11/04/2020 - 12:19
a
10020
14
Md Hasan Uz Zaman's picture
Md Hasan Uz Zaman
10/21/2020 - 02:53
b
9878
6
Nafeez Imtiaz Hossain's picture
Nafeez Imtiaz H...
10/16/2020 - 14:30
a
9830
14
Rakhi Gupta's picture
Rakhi Gupta
10/10/2020 - 15:26
b
9774
6
Shakhaoat Hossain shibly's picture
Shakhaoat Hossa...
10/01/2020 - 20:08
a
9746
14
Md Hasan Uz Zaman's picture
Md Hasan Uz Zaman
08/29/2020 - 01:16
a
5289
14
Md Hasan Uz Zaman's picture
Md Hasan Uz Zaman
08/29/2020 - 17:47
a
9540
14
Rakhi Gupta's picture
Rakhi Gupta
08/24/2020 - 22:08
a
9520
14
Lokonath Debnath's picture
Lokonath Debnath
08/13/2020 - 22:15
a
9380
14
Abhro Gourab Das's picture
Abhro Gourab Das
07/17/2020 - 21:12
a
9292
14
Nafeez Imtiaz Hossain's picture
Nafeez Imtiaz H...
07/07/2020 - 17:29
a
9290
14
Naeem Malik
04/12/2020 - 21:03
a
9122
14
Apurba nandy's picture
Apurba nandy
03/02/2020 - 20:18
a
8968
14
Nafeez Imtiaz Hossain's picture
Nafeez Imtiaz H...
02/20/2020 - 22:12
a
8750
14
Kamrunnahar Takia's picture
Kamrunnahar Takia
02/19/2020 - 20:23
a
8694
14
Kamrunnahar Takia's picture
Kamrunnahar Takia
02/19/2020 - 20:42
b
8706
6