Question
PHITBIT Limited has managed to successfully tender for the government contract to manufacture wearable contact tracing devices. The finance director in preparing to draft a
PHITBIT Limited has managed to successfully tender for the government contract to manufacture wearable contact tracing devices. The finance director in preparing to draft a proposal to the board of directors with a plan to expand existing production lines and facilities to manufacture the tracing devices.
This project will involve the purchase of new equipment at a cost $10 million. An additional $200 000 installation is required to integrate the new machines to existing ones in the production line. The existing machines were acquired at a cost of $50 million five years ago.
Although the cash flows arising from this tracing device is not easy to estimate, you have projected three sets of cash flow under different scenarios; pessimistic, most likely, and optimistic. The finance director wish to evaluate all three scenarios for justification to the board.
There is no scrap value for the equipment at the end of useful life. The cash flows projections for the next five years are as follows:
The company has a 12% cost of capital. Required:
(a) Calculate each scenarios Payback Period.
(b) Calculate each projects Net Present Value (NPV). Briefly discuss the result under the different scenarios
(c) Calculate each projects Profitability Index (PI). Briefly discuss the result under the different scenarios
(d) Critically assess the strengths and weaknesses of both the Net Present Value and Payback Period technique to the finance director as a tool for the evaluation for this project. Provide support for your answer.
1 2 3 4 5 4,000,000 1,800,000 4,500,000 1,500,000 5,000,000 1,200,000 5,500,000 1,000,000 4,500,000 1,000,000 Year (t) Pessimistic Cash Inflows ($) Cash Outflows ($) Most Likely Cash Inflows ($) Cash Outflows ($) Optimistic Cash Inflows ($) Cash Outflows ($) 6,500,000 1,800,000 7,500,000 1,500,000 10,000,000 1,200,000 8,000,000 1,000,000 7,000,000 1,000,000 8,000,000 1,800,000 9,500,000 1,500,000 12,000,000 1,200,000 10,000,000 1,000,000 8,000,000 1,000,000Step by Step Solution
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