Radiant Roses Pty Ltd (RRPL) is a nursery in the Dandenong hills outside Melbourne. To date, RRPL has supplied roses only on a wholesale basis to retail nurseries in Melbourne. RRPL has not sold roses to the public, nor does it have a nursery that is open to the public. The retail price of a rose is usually about 50% higher than its wholesale price. Arianne Thomas and her husband Tim are the only shareholders in RRPL.

Arianne has been investigating the possibility of RRPL selling roses direct to the public (at prices averaging 40% higher than their wholesale equivalent) and also allowing the public to visit the nursery for two months every spring. During this period, RRPL will sell coffee and tea to visiting members of the public. RRPLs bank has approved a principal-and-interest loan for this purpose at an interest rate of 6.8% p.a., payable quarterly. RRPL will also need to buy public liability insurance to cover the possibility of injury to visiting members of the public.

Arianne wishes to evaluate the proposal using the net present value approach and she has asked you for advice. For each of the five cash flows below, indicate whether the cash flow should be included or excluded from the NPV analysis and explain why. In your explanation, clearly identify any related cash flows that you believe Arianne has overlooked and briefly explain why this is the case. (Note: You are not required to do any calculations. You are also not required to suggest cash flows unrelated to these five cash flows that you may think Arianne has overlooked.)

Note: You may type your responses to each part in the spaces provide below. Alternatively, you may upload your handwritten and scanned answers to each question part below. (Do not upload the answers to any other questions here as they will not be marked.)

Q3.1 Question 3.1

2 Points

Cash flow 1 (CF1): Interest payable to the bank. (Your answer must begin with Include or Exclude followed by your explanation.)

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Include, the interest payment can be treated as the cost of capital.

Q3.2 Question 3.2

2 Points

Cash flow 2 (CF2): Principal repayments on the bank loan. (Your answer must begin with Include or Exclude followed by your explanation.)

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Include. This is the cash out flow of the capital.

Q3.3 Question 3.3

2 Points

Cash flow 3 (CF3): Revenues from the sale of roses to the public. (Your answer must begin with Include or Exclude followed by your explanation.)

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Include.

Q3.4 Question 3.4

2 Points

Cash flow 4 (CF4): The cost of public liability insurance. (Your answer must begin with Include or Exclude followed by your explanation.)

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Exclude. This is because it can be treated as a sunk cost

Q3.5 Question 3.5

2 Points

Cash flow 5 (CF5): Revenues from the sale of tea and coffee. (Your answer must begin with Include or Exclude followed by your explanation.)