Your company has asked you to evaluate the following investment opportunity and to recommend an appropriate method of finance.

It will cost £5,000,000 to purchase the Property Plant and Equipment which has an Estimated Residual Value (Scrap Value) of £500,000 at the end of its 5-year life.

Additional annual revenues, over the 5 year life of the project are expected to be, £2,500,000 in the first year based on forecast sales of 1,000,000 units at £2.50 each, then increase in line with inflation and an anticipated 10% increase in volume each year.

In terms of costs, the following additional annual costs are forecast: Labour

Materials €300,000

Overheads (Fixed Costs) £250,000

Overheads (Variable Costs) £350,000 £0.80 per unit

Government data suggests that Inflation over the period, together with volume increases will have the following impact:

Selling prices will rise by 4% p.a.

Material costs will rise by 5% p.a. and Labour costs by 6% p.a.

General inflation is expected to run at the rate of 2% p.a.

The bank has agreed to provide a loan of up to £3,000,000 at a Floating Rate of Base + 6% over 5 years. The remainder (or if you prefer, all or part the finance) will need to be raised by issuing ordinary shares at £1 each. The latest Dividend was 3% but dividends are expected to grow in future years by 8% p.a.

Your company are of course subject to UK Corporation Tax but the Property Plant & Equipment will be eligible for any appropriate, capital and annual investment allowances

Required:

• Justifying your recommended Method of Financing the Project.

This should include reference to:

finance theory and practice

your calculation of the cost of capital and

your calculation of the optimal capital structure

Evaluate the Project using appropriate Investment Appraisal Techniques Compare your Project to the following alternative and recommend which project you would select if capital was rationed to £5,000,000

Alternative Project:

Capital Investment: £4.5 M

Payback: 3 years

NPV: £2.0M

IRR: 32%

If you could Lease the Property Plant & Equipment, calculate the maximum annual lease payment you would be prepared to pay, and evaluate Leasing versus Acquisition, recommending a course of action.