ABC ltd is a hypothetical producer of healthcare consumables. Currently, the company employs 20 workers at 30,000 per annum each. Predicting a continual demand for masks after the pandemic due to cultural and behavioural changes, the owner of the company intends to install a mask production line to produce high-grade air-filtering masks during the next four years. The cost of buying and installing such a production line is 200,000. The production line could be installed in the warehouse of 100m² that the owner owns. The warehouse is currently unoccupied and could earn its owner 15,000 per annum in rent if let out on 01/01/2022. The cost of deep cleaning the warehouse and making the space suitable to install the production line and produce the high-grade masks is 100,000. The owner is told that the production line could be installed by the end of 2021 and ready for operation at the beginning of 2022.

The owner of the company would be happy to take up the insurance policy at a cost of 20,000 per annum to ensure the smooth running of the production line in addition to the standard maintenance expenses of 20,000 per annum. The owner does not expect any scrap value at the end of the fourth year.

The owner of the company plans to hire three workers at a cost of 30,000 per annum each to run the production line and employ a quality controller at a cost of 40,000 p.a. to ensure that the produced masks meet the UK quality standards. The workers must be trained at a cost of 1,000 each before they operate the machines in the mask production line. The production line under the three workers can produce 25,000 masks per day, which require 7000 worth of raw material. Expecting possible restrictions by the supply of the raw material, the company estimates that the production line could run for 200 days per annum. It is estimated that the electricity and water bill for this production line will be 10,000 per annum. The owner is confident that 95% of the masks they produce will meet the quality requirements. The masks could be sold in a box of 50 for 20 to healthcare suppliers.

Assume that:

• all items given above are at the prices of 2021 and the annual inflation rate applicable to all these items is predicted to be 2% in the life span of the project
• capital allowance rate (on the reducing balance scheme) is 25% per annum
• the current corporation tax rate is 28% and the tax is paid (or tax rebate is received) without any delay (that is, in the year when it accrues)
• the owner's expected rate of return on this investment is 15%.

Required:

1. Set up a table to show the derivation of annual gross profits during the life span of the project.
2. Set up a table or tables to show the derivation of annual tax payment or tax rebate over the life span of the project.
3. Set up a table or tables to show the derivation of net annual cash flows of the project.
4. Calculate the NPV of this project and recommend whether the company should accept or reject this project.
5. Explain why the owner's expected rate of return is as high as 15% when the interest rates are very low currently in the UK. Use information specific to this project to support your explanation.

To answer the question, here is a sample question with the answer to explain how to answer

Parameters Nominal terms Inflation rate 6% Scrap value year 5 85000 Discount rate (nominal) 15% Net operating income 320000 Capital allowance rate 20% Corporation tax 19% Time period (years) - cash flow at the end of the period 2 3 Inflation factors (to end of year) 1.0000 1.0600 1.1236 1.1910 1.2625 1.3382 Investment related Machine purchase -500000 Machine scrap 113749 Depreciation Residual value 500000 400000 320000 256000 204800 113749 Capital allowance (20%) 100000 80000 64000 $1200 91051 Opportunity cost Premises -150000 200734 Working capital Funds allocated -40000 -2400 -2544 -2697 -2858 50499 Income related Net operating income 0 339200 359552 381125 403993 428232 Cash flow calculation Operating income 0 339200 359552 381125 403993 428232 Taxable income 239200 279552 317125 352793 337181 Tax 0 45448 53115 60254 67031 64064 Income after tax 0 293752 306437 320871 336962 364168 Total cash flow -690000 291352 303893 318175 334104 729150 Net present value PV factors (nominal 15.00%%) 100000 0.86957 0,75614 0.65752 0.57175 0,49718 PV annual cash flow -690000 253350 229787 209205 191025 362516 NPV - 555883 Payback period -690000 -398648 -94755 223420 557523 1286673 2.331 years 2.2978082? Diageo Plc is considering launching a new alcoholic product called I'Eilamboo'. The nance department have been called in to perform a project valuation. This Is to be done using the NP'v' and payback methods. The company uses a discount rate of 15% per year In nominal terms but prices and costs have been estimated In gal terms. The ination rate is taken to be 6% per year over the life of the project which is to be 5 years. FIELD costs prior to the start of the project have been 20,000. Premises to be used to house the manufacturing facility are already owned by the company but would be sold for 150,000 if the project Is not undertaken. It Is assumed that the value of the premises will be maintained at the same level in real terms and will become available at the end of the project. The cost of equipment, which is required immediately, Is 500,000 and this Is subject to a capital allowance of 20% per year using the declining balance method. At the end of the project it is estimated that the equipment can be sold for 35,000 in real terms. Working capital of 40,000 ls required and this must be adjusted at the end of each year to account for Ination. This wili be returned at the end of the project. The net operating income per year is expected to be 320,000. It may be assumed that all cash flows are affected by Ination and at the same percentage per year. Corporation tax Is 19% per year. Required: to) Create a table showing all the relevant cash flows In nominal terms. Explain any calculations you make. (60%) {b} Calculate the payback period. (was) to} Calculate the project's may. (20%) {d} Would you recommend that the project is undertaken? Explain the reason for your opinion. (10%)