Answered: 1 st year 2nd year Scenario A Scenario…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

See similar textbooks

Related questions

Question

Part A

A software company is considering launching a new product in the market. To record consumer behavior, the company participated in two domestic software fairs in Athens and Thessaloniki that costed €7,000. The results showed that there are two Scenarios (A and B) whose probabilities of occurrence are 60% and 40% respectively, based on consumers’ willingness to buy the new product. To start production, €100,000 is required for new machinery, plus another €2,000 for transport costs and €1,000 for installation costs. This is a state-of-the-art technology machinery, thus, its economic life is only two years. The new machinery will be fully depreciated at the end of its economic life and the company applies the straight-line depreciation method. Table 1 shows the estimated figures on sales, variable costs, selling price, management and distribution costs and working capital needs. At the end of the second year the working capital will be recovered.

Table 1: Estimated financial data (PLEASE SEE THE IMAGE ATTACHED)

The tax rate is 25%. The company will finance the investment by 2/6 with new share capital, and by 4/6 with a new bond. The cost of share capital is 10% while the (pretax) cost of debt is 8%. Questions:

a) Calculate the annual expected net cash flows of the project.
b) Calculate the respective, per year, standard deviations, and coefficients of variation of the net cash flows, and comment on the findings.
c) Calculate the Weighted Average Cost of Capital.
d) Evaluate the investment using the Net Present Value (NPV) method.

Part B

Comment on the key differences between the Net Present Value (NPV) and the Internal Rate of Return (IRR).
Should investment appraisal methods use real or nominal cash flows? Explain.