The Management of Bridge Link Co are considering a planned investment project costing $25m, payable at the start of the first year of operation. The following information relates to the investment project:

Year 1 Year 2 Year 3 Year 4

Sales volume (units/year) 520,000 624,000 717,000 788,000

Selling price ($/unit) 3000 3000 3000 3000

Variable costs ($/unit) 1000 1020 1061 1093

Fixed costs ($/year) 700,000 735,000 779,000 841,000

This information needs adjusting to take account of selling price inflation of 4% per year and variable cost inflation of 3% per year. The fixed costs, which are incremental and related to the investment project, are in nominal terms. The year 4 sales volume is expected to continue for the foreseeable future. Bridge Link Co pays corporation tax of 30% one year in arrears. The company can claim tax-allowable depreciation on a 25% reducing balance basis. The views of the directors of Bridge Link Co are that all investment projects must be evaluated over four years of operations, with an assumed terminal value at the end of the fourth year of 5% of the initial investment cost. Both net present value and discounted payback must be used, with a maximum discounted payback period of two years. The real after-tax cost of capital of Bridge Link Co is 7% and its nominal after-tax cost of capital is 12%.

REQUIRED

a) Calculate the net present value of the planned investment project and comment on the results. [7Marks]

b) Calculate the return on capital employed (Accounting rate of return) based on average for the investment project. [5Marks]

c) Determine the basic payback period of the above project and comment on the results [5Marks] d) Calculate the Project IRR and ARR [8Marks]

e) Briefly identify any TWO weakness of EACH of the following project appraisal methods. [10Marks]

f) Briefly explain why the following elements are likely to be excluded from the cash flows in project appraisal

i. Research cost incurred prior to the start of the project

ii. Apportioned fixed costs. [5Marks] [Total:20Marks]