Question 3

Eddie Wilmott Ltd (a haulage company) is considering investing in a new project as

part of their expansion plan. Out of a number of options, two projects have emerged

as potential investment areas:

1. The creation of a new busines division: EW Biomass, specialising in logistics

solutions for greener energy.

2. The expansion of current traditional haulage operations via the purchase of a

smaller competitor: James Ireland Ltd, broadly in the same business sector.

Data pertaining to the relevant cash flows associated with each potential investment

project is as below:

Year EW Biomass Purchase of James Ireland Ltd

.

0. -40,000,000 -25,000,000

1 -5,500,000 10,000,000

2 5,000,000 12,000,000

3 7,500,000 12,500,000

4 19,000,000 9,500,000

5 22,000,000 8,000,000

Additional information related to the two projects is as follows:

(i) Green energy is a growth market in the country that Eddie Wilmott Ltd operates

in. It is considered that the EW biomass cash flows will peak in year five of the

project, but be sustained around this level until ten years following the

commencement of the project.

(ii) The cash flows related to James Ireland Ltd are expected to follow their current

trends for the twenty years following the purchase of the company.

(iii) James Ireland Ltd is currently valued at approximately 17 million on its latest

set of financial statements. The difference between this value and the purchase

price is expected to be a premium that shareholders of James Ireland Ltd will

demand in order to sell.

(iv) Eddie Wilmott Ltd currently operates with a company policy that any new

investment project must have a payback period of under four years, and

generate positive net present value.

(v) The cost of capital for both projects has been estimated at 6% per annum.

REQUIRED:

(a) For the two potential investments described in the question, prepare the

following investment appraisal calculations:

Payback Period

Accounting Rate of Return (based on the initial investment method, and

assuming that relevant cash flows equal annual profits)

Net Present Value

(16 Marks)

(b) Write an email to the finance director of Eddie Wilmott Ltd detailing your

recommendation regarding which investment(s) to pursue, based on both your

financial analysis, and the additional information given in the question.

(14 Marks)

(500 words)

(Total: 30 marks)