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Question 2 EFG plc has budgeted the following results for the coming year. Sales units Probability 30,000 0.30 40,000 0.40 50,000 0.30 The budgeted sales
Question 2 EFG plc has budgeted the following results for the coming year. Sales units Probability 30,000 0.30 40,000 0.40 50,000 0.30 The budgeted sales price is K10 per unit and the expected cost of materials is as follows: Cost per unit of output (K) Probability 4 0.20 6 0.60 8 0.20 Materials are the only variable cost. All other costs are fixed and are budgeted at K100,000. Required: a. Calculate the expected profit for EFG plc from the above data. (4 marks) b. EFG plc is considering investing in different projects with the following data available: Project Alpha Omega Gamma Expected return 14% 12% 17% Correlation of returns with the market 0.62 0.75 0.58 Standard deviation of returns 3.7% 4.1% 6.5% The expected return is 15%, the standard deviation of the market is 4.8% and the risk free rate of return is 8%. Required: Recommend which of the above projects should be undertaken, assuming the projects are mutually exclusive. (4 marks) c. EFG plc plans to buy a new machine to meet expected demand for a new product Theta. This machine will cost K250,000 and last for four years, at the end of which time it will be sold for K5,000. EFG plc expects demand for Theta to be as follows: 3 Year 1 2 3 4 Demand in units 35,000 40,000 50,000 25,000 The selling price for Theta is expected to be K12.00 per unit and the variable cost is expected to be K7.80 per unit. Fixed costs of K25,000 per year will be incurred. Selling price and costs are expected to increase as follows: Increase Selling price of Theta 3% per year Variable costs 4% per year Fixed costs 6% per year EFG plc can claim capital allowances on a 25% reducing balance basis. Discount rate is 11%. Required: (i) Calculate the net present value of the project and explain the key benefits of the net present value approach. (12 marks) (ii) Assess the sensitivity of the following variables: initial investment, selling price, sales volume, variable costs and fixed costs. (5 marks)
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