Question
Superfoods Ltd is a business that specializes in the marketing and distribution of nutritional supplements and personal care products. The company spent $90,000 on research,
Superfoods Ltd is a business that specializes in the marketing and distribution of nutritional supplements and personal care products. The company spent $90,000 on research, and based on information uncovered from the research, the company has decided to capitalize on the exercise fad and open a fitness centre in conjunction with its main health foods store. To get the project under way, the company will rent additional space adjacent to its current store. Special equipment required for the fitness centre will cost $850,000. Shipping and installation charges for the equipment are expected to total $150,000. This equipment will be depreciated on a straight-line basis over its five-year economic life to an estimated salvage value of $0. To open the fitness centre, Superfoods estimates that it will have to add about $100,000 to its net working capital in the form of additional inventories of exercise supplies, cash, and accounts receivable for its customers. Overhauling of the equipment will take place in year 4 at a cost of $50,000. During the first year of operations, Superfoods expects its total revenues from sales and the fitness centre to increase by $400,000 above the level that would have prevailed without the exercise facility addition. These incremental revenues are expected to grow by 5% in years 1 to 3 and decline by 4% in years 4 and 5. The companys incremental operating costs associated with the fitness centre, including the rental of the facility, are expected to total $125,000 during the first year and increase at a rate of 6 percent per year over the five-year project life. The company has a cost of capital of 12% and pays corporation tax at 25 percent. Required:
(g) The company is considering another investment which would have an initial cost of $900,000 and an NPV of $50,000. There is a situation of capital rationing, and you have suggested that the firm should use the profitability index to choose which investment to implement. Advise the company. [5 marks]
(h) Discuss THREE non-financial factors which the firm should consider when making investment decision.
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