Question 1 Lynton plc is a UK listed company that is planning to meet increased demand for its products by purchasing new machinery on January 1st at a cost of 5 million. The machinery will last for four years, at the end of which the scrap value is expected to be 5% of the initial cost. Capital allowances are available on the machinery at 25% on a reducing balance basis, with a balancing allowance or charge in the final year of use. The investment in machinery will increase production capacity by 9,000 units per year and all units are expected to be sold as they are produced. Relevant financial information in current price terms is as follows: Item Selling price Variable cost Incremental fixed costs Item value 650 per unit 250 per unit 250,000 per year Forecast inflation 4.0% per year 5.5% per year 5.0% per year An investment in working capital of 10% of sales revenue will need to be in place at the start of each year to which the sales relate. Lynton plc pays tax on profits at the rate of 30% per year and tax is paid at the end of the year to which it relates. The company has an after-tax weighted average cost of capital of 10% per year. Requirements (a) Calculate the net present value (NPV) of the planned investment in new machinery and comment on its financial acceptability. (20 marks) (b) Describe and critically discuss the use of sensitivity analysis and probability analysis as ways in which risk can be incorporated into the investment appraisal process. Refer in your answer to the relative effectiveness of each method. (10 marks) (c) Calculate the sensitivity of the planned investment to changes in selling price and comment on the result. (5 marks) [Total: 35 marks] Question 1 Lynton plc is a UK listed company that is planning to meet increased demand for its products by purchasing new machinery on January 1st at a cost of 5 million. The machinery will last for four years, at the end of which the scrap value is expected to be 5% of the initial cost. Capital allowances are available on the machinery at 25% on a reducing balance basis, with a balancing allowance or charge in the final year of use. The investment in machinery will increase production capacity by 9,000 units per year and all units are expected to be sold as they are produced. Relevant financial information in current price terms is as follows: Item Selling price Variable cost Incremental fixed costs Item value 650 per unit 250 per unit 250,000 per year Forecast inflation 4.0% per year 5.5% per year 5.0% per year An investment in working capital of 10% of sales revenue will need to be in place at the start of each year to which the sales relate. Lynton plc pays tax on profits at the rate of 30% per year and tax is paid at the end of the year to which it relates. The company has an after-tax weighted average cost of capital of 10% per year. Requirements (a) Calculate the net present value (NPV) of the planned investment in new machinery and comment on its financial acceptability. (20 marks) (b) Describe and critically discuss the use of sensitivity analysis and probability analysis as ways in which risk can be incorporated into the investment appraisal process. Refer in your answer to the relative effectiveness of each method. (10 marks) (c) Calculate the sensitivity of the planned investment to changes in selling price and comment on the result. (5 marks) [Total: 35 marks]
