Hitech Solutions plc is a company quoted on a major stock exchange. The company has a mix of finance and is currently structured with 50% equity and 50% long term debt (corporate bonds). It is thought that if the project, below, is pursued, then the company will need to resort to finance markets in order to raise the necessary initial investment funds.

From January 2021 the company has researched into solar power for mobile phones and has had some success with developing the appropriate component units. Although Hitech Solutions is an innovative company this is a new development area for it and the company has so far spent 9 million on research and development. However, due to the success, it plans to sell the units to mobile phone manufacturers as from January 2022. Although Hitech Solutions has a first developer advantage it is recognised that other companies will join the market, and as such it is only worth modelling potential outcomes for 4 years.

The necessary equipment, and infrastructure changes, to manufacture the solar component units will require an investment of 23 million, payable before production begins. It is estimated that this initial investment in production facilities will have a scrap or salvage value at the end of the project (2025) of 1 million. In order to develop a market amongst mobile phone manufacturers Hitech Solutions has also spent 5 million on marketing expenses during 2021.

After a good deal of financial and market forecasting the company has budgeted as follows for future sales, revenues and costs:

	2022	2023	2024	2025
Sales (units)	310,000	425,000	545,000	210,000
Selling price (/unit)	130	140	149	130
Variable cost (/unit)	82	90	98	101
Incremental Fixed costs ()	3,100,000	3,800,000	4,700,000	3,150,000

The company has budgeted all data in current price terms before applying inflation. Any changes in price, above, are due to market strategic factors, and any changes in costs are due to changes in the factory manufacturing processes, as a whole. However, it is recognised that there is inflation within the economy. The general rate of inflation in the economy is forecast, by the government, to be stable at 5.5% per annum. However, due to international pressure on material and labour availability it is thought that variable costs will inflate at 6% per annum. Similarly, due to international market pressures on energy it is thought that fixed costs will be inflating at 7%. In order to counteract these costs increases, to some extent, Hitech Solutions is of the opinion that it will inflate selling price by 3% per year. The increases are modest in order to attempt to deter market competitors.

The finance experts within the company are of the opinion that Hitechs investors will require a weighted real return of 8% per annum over the course of the project.

The management team is also aware that on average the industry is working to an acceptable Return on Capital Employed of 20%. This is well known by stock market investors.

At a meeting to discuss the proposal, the following conversations are heard:

Linda Hickson the Finance executive, says, We obviously need to calculate the Net Present Value (NPV), in order to ascertain if the project would be worthwhile.

Tom Webster, who is a senior manager in the manufacturing side of the business, responds, Ive seen organisations calculate the NPV before, and to be honest, I have no idea what it means. Couldnt we calculate a percentage return, so that we can see exactly where we stand with this project? Linda replies, Ok, maybe we could calculate the Internal Rate of Return (IRR). This would give us a percentage return and then we would know what action to take.

At this point Darren Sparkes, the companys Business Analyst, joins in and says, I actually studied accounting at university and arent both of these methods, NPV and IRR, something to do with the time value of money? If I am totally honest, I found this concept to be quite confusing. Couldnt we simply use accounting data and ignore the time value of money? I dont see the need to over-complicate the issue.

Others in the meeting find this discussion, concerning project appraisal methodologies, to be quite boring and not too important, and soon, Samuel Komakech (HR Manager) moves the conversation on to financing. Samuel asks, Where are we going to find the money for the initial investment? I remember from studying some finance on my Chartered Institute of Personnel and Development examinations that it is supposedly cheaper to use long term debt, as opposed to equity, for financing long term projects. My memory is slightly hazy, and I dont remember all of the detailed arguments, but I, therefore, presume that we will be borrowing the money. A conversation follows this declaration, but the members of the meeting do not feel sufficiently knowledgeable to form a decision.

Niloufer Abdool, has been following the conversations keenly and is an assistant to Linda Hickson, the Finance executive. She says, As I am studying part-time for a MBA, I came prepared and have an extract from an article with me. This comes from some work we considered on Real Options Analysis (ROA), and I wonder if this would be helpful to our current decision. At this she reads a section from the article. Real Options constitute a tool to mitigate uncertainty in an investment project by instituting an option based on income generation by the project in which managers have flexibility in the decision-making concerning its further progress, (Rogulenko et al, 2021, p8).

Niloufer goes on to say, I must admit that I found the mathematics of this approach slightly confusing, although I thought that the strategic factors highlighted by the model were very useful, although I cant quite remember them all. I must also admit I was all a little lost with regard to what the main difference was between this approach and the straightforward NPV methodology. Understandably many others at the meeting are also rather confused and it is decided to undertake some more research into the ROA appraisal approach.

As the meeting is drawing to a close, Kiranjyot Kaur, who is the Marketing manager, says, Are we sure that we are doing the right thing? Ive heard that a potential competitor in this industry is suffering from cash flow problems, and we may be able to buy this company, and utilise its spare production capacity and expertise as opposed to developing our own.

After lengthy discussions (the above are only extracts) the meeting decides to approach a company of Business Consultants.

In your role as a Business Consultant, you are required to respond as follows, in order to satisfy the above queries:

Task One

1. In order to assist Linda Hickson, Tom Webster and Darren Sparkes you are required to calculate:

1. Net Present Value (7 marks)
2. Internal Rate of Return (2 marks)
3. Average Accounting Rate of Return (4 marks)