Question 1

2 projects:

• Project 1: - A car with a cost of $150,000 and a useful life of 3 years. It will produce rental income of $110,000 per year and operating costs of $20,000 per year. A major service is required after 2 years costing $15,000. A salvage value of $40,000 is expected after 3 years. The required return is 10%.

• Project 2: - A 4-wheel drive vehicle costing $250,000 but with an expected useful life of 5 years. It will produce rental income of $140,000 per year and operating costs of $30,000 per year. A major service is required after 3 years costing $20,000. A salvage value of $50,000 is expected after 5 years. The required rate of return is 13%.

Income tax can be ignored.

Solve for.

(1)The NPV's of the two cars.

(2)An analysis of the two cars assuming they are mutually exclusive and can be repeated indefinitely.

Question 2.

As the financial advisor to X company, you are evaluating the following new investment in a manufacturing project: -

• The project has a useful life of 8 years.
• Cost of land is $10m and is estimated to have a resale value of $15m at the completion of the project.
• Buildings cost $12m, with allowable depreciation of 6% pa reducing balance and a salvage value of $10m.
• Equipment costs $5m, with allowable depreciation of 10% pa reducing balance and a salvage value of $1m. An investment allowance of 20% of the equipment cost is available.
• Revenues are expected to be $15m in year one and rise at 5% pa.
• Cash variable costs are estimated at 30% of revenue.
• Cash fixed costs are estimated at $3m pa.
• Managerial salaries of $800,000 will be allocated to the project, but these managerial positions will be unaffected by the acceptance of the project.
• An amount of $200,000 has been spent on a feasibility study for the new project.
• The project is to be partially financed with a loan of $13.5m to be repaid annually with equal instalments at a rate of 5% pa over 8 years.
• Except for initial outlays, assume cash flows occur at the end of each year.
• The tax rate is 30% and is payable in the year in which profit is earned.
• The after-tax required return for the project is 11% pa.

Solve for:

(a)Calculate the NPV.Is the project acceptable? Why or why not?

(b)Conduct a sensitivity analysis showing how sensitive the project is to revenues, fixed costs and to the required rate of return. Explain your results.