Advanced: Calculation of NPV and additional cash flows which will result in a zero NPV Losrock Housing Association is considering the implementation of a refurbishment programme on one of its housing estates which would reduce maintenance and heating costs and enable a rent increase to be made.

Relevant data are as follows:

(i) Number of houses: 300.

(ii) Annual maintenance cost per house: £300. This will be reduced by 25% on completion of the refurbishment of each house.

(iii) Annual heating cost per house: £500. This will be reduced by 30% on completion of the refurbishment of each house.

(iv) Annual rental income per house: £2100. This will be increased by 15% on completion of the refurbishment of each 1ouse.

(v) Two ,;ontractors A and B have each quoted a price of

£2000 per house to implement the refurbishment work.

(vi) The quoted completion profiles for each contractor are as follows:

(vii) Contractor A requires £100000 at the commencement of the work and the balance of the contract price in proportion to the number of houses completed in each of years 1 to 3.
Contractor B requires £300 000 at the commencement of the work and the balance of the contract price in proportion to the number of houses completed in each of years 1 to 3.
(viii) An eight year period from the commencement of the work should be used as the time horizon for the evaluation of the viability of the refurbishment programme.
Assume that all events and cash flows arise at year end points.
Savings and rent increases will commence in the year following refurbishment.
Ignore taxation.
Required:

(a) Prepare financial summaries and hence advise management whether to accept the quote from contractor A or contractor B in each of the following situations:
(i) ignoring the discounting of cash flows; and (ii) where the cost of capital is determined as 14% and the discount factors given in Appendix A are available.
(14 marks)

(b) For contractor A only, calculate the maximum refurbishment price per house at which the work would be acceptable to Losrock Housing Association on financial grounds using discounted cash flows as the decision base, where the initial payment remains at £100 000 and the balance is paid in proportion to the houses completed in each of years 1 to 3.
(5 marks)

(c) Suggest additional information relating to maintenance and heating costs which might affect the acceptability of the existing quotes per house where discounted cash flows are used as the decision base.

Transcribed Image Text:

Number of houses refurbished Year 1 Contractor A Contractor B 90 150 Year 2 990 Year 3 120 60