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Jungleland Co. is appraising an investment project which has an expected life of 4 years and is a one-off project that will not be repeated.
Jungleland Co. is appraising an investment project which has an expected life of 4 years and is a one-off project that will not be repeated. The initial investment will cost $6million, payable at the start of the project, and will have a value at the end of the 4 years of $1 million. There is some uncertainty in respect of the selling price that Jungleland could charge but the following data has been collected in respect of the future state of the economy. Future economic state Weak Medium Strong Probability of future economic state 30% 50% 20% Selling Price in current price terms $24 $28 $34 These selling prices are expected to be subject an annual inflation rate at 5% per year. Forecast sales and production volumes are as follows: Year 1 Year 2 Year 3 Year 160,000 units 240,000 units 420,000 units 280,000 units The nominal variable costs for each of the 4 years are as follows: Year 1 Year 2 Year 3 Year 4 $2,500,000 $4,100,000 $6,900,000 $5,500,000 Fixed incremental overheads are $500,000 per annum increasing at a rate of inflation of 5% per year. The initial investment will attract tax allowable depreciation (capital allowances) of 25% on a reducing balance basis. Corporation tax is 20% and tax benefits and liabilities arise in the year that they become due. Jungleland Co. has traditionally used a weighted average cost of capital of 7%. Required: (a) Calculate the net present value of this investment project and comment on its financial acceptability. [20 marks] (b) Critically discuss if the sensitivity analysis would assist River Co. in assessing the business and financial risk of this project. [10 marks]
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