Question 2. Capital investment Norman Harvey Ltd is considering building a warehouse/pick up centre. They have paid an architect $15,000 to design the warehouse. The warehouse will cost $100,000 to build. They expect the warehouse to last 10 years and they plan to use straight line depreciation and depreciate it to zero. It will make inventory more efficient, so they will need to stock $10,000 less inventory. They believe this warehouse/pick up centre will result in additional sales of $20,000 per year. The cost of producing these sales will be 40% of sales. (This does not include depreciation, but does include an allocated overhead charge of 1% of sales.) Norman Harvey has a marginal tax rate of 30% and believes the opportunity cost of capital for a project like this should be 12%. Formulas are provided on the last pages of this question booklet. Required: Show your workings! a. Draw a timeline for this project. (2 marks) What are the appropriate cash flows for year 0? (2 marks) What are the appropriate operating cash flows for years 1-9? (7 marks) d. What are the appropriate cash flows for year 10? (2 marks) e. Find the Net Present Value of this project. (5 marks) f. Should Norman Harvey do this project? Why or why not? (2 marks) g. Would you expect the Internal Rate of Return of this project to be above or below 12%? Why? (2 marks) TOTAL: 22 MARKS Question 2. Capital investment Norman Harvey Ltd is considering building a warehouse/pick up centre. They have paid an architect $15,000 to design the warehouse. The warehouse will cost $100,000 to build. They expect the warehouse to last 10 years and they plan to use straight line depreciation and depreciate it to zero. It will make inventory more efficient, so they will need to stock $10,000 less inventory. They believe this warehouse/pick up centre will result in additional sales of $20,000 per year. The cost of producing these sales will be 40% of sales. (This does not include depreciation, but does include an allocated overhead charge of 1% of sales.) Norman Harvey has a marginal tax rate of 30% and believes the opportunity cost of capital for a project like this should be 12%. Formulas are provided on the last pages of this question booklet. Required: Show your workings! a. Draw a timeline for this project. (2 marks) What are the appropriate cash flows for year 0? (2 marks) What are the appropriate operating cash flows for years 1-9? (7 marks) d. What are the appropriate cash flows for year 10? (2 marks) e. Find the Net Present Value of this project. (5 marks) f. Should Norman Harvey do this project? Why or why not? (2 marks) g. Would you expect the Internal Rate of Return of this project to be above or below 12%? Why? (2 marks) TOTAL: 22 MARKS
