Candlex Ltd Co is appraising an investment project which has an expected life of four years and which will not be repeated. The initial investment, payable at the start of the first year of operation, is K5 million. Scrap value of K500, 000 is expected to arise at the end of four years.There is some uncertainty about what price can be charged for the units produced by the investment project, as this is expected to depend on the future state of the economy. The following forecast of selling prices and their probabilities has been prepared:Future economic state Weak Medium StrongProbability of future economic state 35% 50% 15%Selling price in current price terms K25 per unit K30 per unit K35 per unitThese selling prices are expected to be subject to annual inflation of 4% per year, regardless of which economic state prevails in the future. Forecast sales and production volumes, and total nominal variable costs, have already been forecast, as follows:Year 1 2 3 4Sales and production (units) 150,000 250,000 400,000 300,000Nominal variable cost (K000) 2,385 4,200 7,080 5,730Incremental overheads of K400, 000 per year in current price terms will arise as a result of undertaking the investment project. A large proportion of these overheads relate to energy costs which are expected to increase sharply in the future because of energy supply shortages, so overhead inflation of 10% per year is expected.The initial investment will attract tax-allowable depreciation on a straight-line basis over the four-year project life. The rate of corporation tax is 30% and tax liabilities are paid in the year in which they arise. The company has traditionally used a nominal after-tax discount rate of 11% per year for investment appraisal.Required:Calculate the expected net present value of the investment project and comment on its financial acceptability. Candlex Ltd Co is appraising an investment project which has an expected life of four years andwhich will not be repeated. The initial investment, payable at the start of the first year ofoperation, is K5 million. Scrap value of K500, 000 is expected to arise at the end of four years.There is some uncertainty about what price can be charged for the units produced by theinvestment project, as this is expected to depend on the future state of the economy. Thefollowing forecast of selling prices and their probabilities has been prepared:Future economic stateWeakMediumStrongProbability of future economic state35%50%15%Selling price in current price termsper unitK25 per unitK30 per unitК35These selling prices are expected to be subject to annual inflation of 4% per year, regardless ofwhich economic state prevails in the future.Forecast sales and production volumes, and total nominal variable costs, have already beenforecast, as follows:Year1234Sales and production (units)150,000250,000400,000300,000Nominal variable cost (K000)2,3854,2007,0805,730Incremental overheads of K400, 000 per year in current price terms will arise as a result ofundertaking the investment project. A large proportion of these overheads relate to energycosts which are expected to increase sharply in the future because of energy supply shortages,so overhead inflation of 10% per year is expected.The initial investment will attract tax-allowable depreciation on a straight-line basis over the four-year project life. The rate of corporation tax is 30% and tax liabilities are paid in the year inwhich they arise. The company has traditionally used a nominal after-tax discount rate of 11%per year for investment appraisal.Required:Calculate the expected net present value of the investment project and comment on its financialacceptability.

As this problem requires lot of calculations, we will use excel to do it. However, first of all, we…

Candlex Ltd Co is appraising an investment project which has an expected life of four years and which will not be repeated. The initial investment, payable at the start of the first year of operation, is K5 million. Scrap value of K500, 000 is expected to arise at the end of four years. There is some uncertainty about what price can be charged for the units produced by the investment project, as this is expected to depend on the future state of the economy. The following forecast of selling prices and their probabilities has been prepared: Future economic state Weak Medium Strong Probability of future economic state 35% 50% 15% Selling price in current price terms per unit K25 per unit кз0 реer unit К35 These selling prices are expected to be subject to annual inflation of 4% per year, regardless of which economic state prevails in the future. Forecast sales and production volumes, and total nominal variable costs, have already been forecast, as follows: Year 1 2 3 4 Sales and production (units) 150,000 250,000 400,000 300,000 Nominal variable cost (K000) 2,385 4,200 7,080 5,730 Incremental overheads of K400, 000 per year in current price terms will arise as a result of undertaking the investment project. A large proportion of these overheads relate to energy costs which are expected to increase sharply in the future because of energy supply shortages, so overhead inflation of 10% per year is expected. The initial investment will attract tax-allowable depreciation on a straight-line basis over the four -year project life. The rate of corporation tax is 30% and tax liabilities are paid in the year in which they arise. The company has traditionally used a nominal after-tax discount rate of 11% per year for investment appraisal. Required: Calculate the expected net present value of the investment project and comment on its financial acceptability.

Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter19: Capital Investment

Section: Chapter Questions

Problem 10E: Roberts Company is considering an investment in equipment that is capable of producing more...

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Candlex Ltd Co is appraising an investment project which has an expected life of four years and which will not be repeated. The initial investment, payable at the start of the first year of operation, is K5 million. Scrap value of K500, 000 is expected to arise at the end of four years. There is some uncertainty about what price can be charged for the units produced by the investment project, as this is expected to depend on the future state of the economy. The following forecast of selling prices and their probabilities has been prepared: Future economic state Weak Medium Strong Probability of future economic state 35% 50% 15% Selling price in current price terms K25 per unit K30 per unit K35 per unit These selling prices are expected to be subject to annual inflation of 4% per year, regardless of which economic state prevails in the future. Forecast sales and production volumes, and total nominal variable costs, have already been forecast, as follows: Year 1 2 3 4 Sales and production (units) 150,000 250,000 400,000 300,000 Nominal variable cost (K000) 2,385 4,200 7,080 5,730 Incremental overheads of K400, 000 per year in current price terms will arise as a result of undertaking the investment project. A large proportion of these overheads relate to energy costs which are expected to increase sharply in the future because of energy supply shortages, so overhead inflation of 10% per year is expected. The initial investment will attract tax-allowable depreciation on a straight-line basis over the four-year project life. The rate of corporation tax is 30% and tax liabilities are paid in the year in which they arise. The company has traditionally used a nominal after-tax discount rate of 11% per year for investment appraisal. Required: Calculate the expected net present value of the investment project and comment on its financial acceptability.

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