Question
Avanti plc is considering a major investment programme which will involve the creation of a chain of retail outlets throughout the United Kingdom. The following
Avanti plc is considering a major investment programme which will involve the creation of a
chain of retail outlets throughout the United Kingdom. The following cash flows are
expected.
Time 0 1 2 3 4
'000 '000 '000 '000 '000
Land and Buildings 3,250
Fittings and Equipment 700
Gross Turnover 1,800 2,500 2,800 3,000
Direct Costs 750 1,100 1,500 1,600
Marketing 170 250 200 200
Office Overheads 125 125 125 125
(a) 60% of office overhead is an allocation of head office operating costs.
(b) The cost of land and buildings includes 80,000 which has been spent on surveyors' fees.
(c) Avanti plc expects to be able to sell the chain at the end of year 4 for 4,000,000.
Avanti plc is paying corporate tax at 30% and is expected to do so for the foreseeable
future. Tax is paid one year in arrears.
The company will claim capital allowances on fittings and equipment at 25% on a reducing
balance basis. Capital allowances are not available on land and buildings.
Estimated resale proceeds of 100,000 for the fittings and equipment have been included in
the total figure of 4,000,000 given above.
Avanti plc expects the working capital requirements to be 15% of turnover during each of
the four years of the investment programme.
Avanti's real cost of capital is 7.7% p.a.
Inflation at 4% p.a. has been ignored in the above information. This inflation will not apply
to the resale value of the business which is given in nominal terms.
Required
a. Calculate the NPV for Avanti's proposed investment and calculate its sensitivity to
changes in the rate of corporation tax (fiscal risk)
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