Case Study 3 Egnaro GmbH (Egnaro) develops, builds and sells holiday apartments at selected locations throughout Europe. The identification of suitable sites is the responsibility of the Development Director, who prepares an initial property survey and market assessment for presentation to the other directors. Decisions to proceed with or reject projects have been taken solely on the basis of this property survey report, which makes no attempt at any financial or investment appraisal." Over its period of existence, Egnaro's record of profitability has been inconsistent. Some sites have proved to be major successes, while others have struggled to break even. Egnaro has recently recruited a new CEO, who has been reviewing some of the past projects and has decided to introduce a greater degree of financial rigour to the analysis of potential projects. She has been stressing to the other directors that the company has only limited investment funds available at any point in time and so it is crucial that future investment decisions are more soundly based from a financial perspective. Egnaro's directors are currently considering a possible project for the construction of apartments on the island of Gozo ('the Gozo project), where the Maltese Government is keen to promote property development of holiday apartments as a means of increasing tourism. The Development Director has already carried out his property survey and market assessment, both of which look promising On the instructions of the CEO, the CFO has met with the Development Director to review the financial aspects of the project. The CFO made the following notes from her meeting with the Development Director for use in her appraisal of the project. The land being offered by the Maltese Government would cost 2m. To assist with Egnaro's cash flow, the Maltese Government is prepared to accept payment in two equal instalments - on 1 January 2020 and 1 January 2022. The funding for the Gozo project is expected to be provided by a secured loan from the company's bankers with an interest charge of 3% per annum. The bank has stated that there will be an initial loan agreement fee of 50,000, payable at the commencement of construction work for the first phase of the project. The project involves the construction of 24 three-bedroom apartments and 100 one-bedroom apartments. Construction is planned in two phases over four years, with the first phase commencing on 1 January 2020. The first phase has a target date of completion of two years, that is, by 31 December 2021. During that first two-year construction phase, 14 three-bedroom apartments and 60 one-bedroom apartments will be built . The remaining apartments will be built during the second two-year phase, which will commence on 1 January 2022 and be completed on 31 December 2023. The three-bedroom apartments will cost 80,000 each to build and the one- bedroom apartments 50,000 each. It has been assumed that building costs will be incurred evenly within each two-year phase of the project. The selling price of the apartments has been set at 175,000 each for the three- bedroom apartments and 75,000 each for the one-bedroom apartments. Although construction will take place in two phases over four years, it has been assumed that sales of the apartments will start on 1 January 2021 and be spread evenly over the next four years, such that all apartments will have been sold by 31 December 2024. Taxation can be ignored. Note: At a discount rate of 12%, the present value of 1 is as follows: End of Period Present Value 0.893 2 0.797 3 0.712 0.636 0.567 1 4 5 Required: 1. Using the information provided by the financial director, carry out a financial assessment of the viability of the Gozo project, using both the net present value method and the discounted payback method of investment appraisal. Show all workings. (14 marks) 2. Comment on the project's commercial attraction in the light of the results from both approaches. (5 marks - maximum word count 300 words) 3. Any investment project carries a variety of risks. Outline possible ways through which the risk factor can be incorporated into a project's financial assessment process. (6 marks - maximum word count 400 words) Total 25 marks