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Investment Appraisal - Report Example

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This work called "Investment Appraisal" focuses on the concept of capital budgeting, selling costs, the role of sales. The author outlines the growth rate and inflation rate, the condition of the economy, consequences on the result of the company. From this work, it is clear about human capital and the supply chain…
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Investment Appraisal
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Download file to see previous pages As we know that the expected inflation rate is 2 % while the real increase in sales and operating costs will be 1 % if the firm does not pursue the project. Therefore by using the above formula we have found the nominal rate to be 3.02% annually.
Penta Ltd has paid £40,000 to buy the land. The total investment required for acquiring the land and the factory is £8million, for which 75% of the funds will be spent one year before the factory becomes operational (2011) and 25% in the following year (2012). This means that £6million will be invested in 2011 and £2million will be invested in 2012.
Sales will grow 30% per year over the first three years of operation in real terms so will adjust for the nominal rate using the formula. After the initial three years, the growth rate will revert to 1% in real terms.
We will convert all the real rates into nominal rates since we are assuming that the project has a nominal weighted average cost of capital. Therefore it is necessary to adjust for the inflation factor before discounting the cash flows.
Since the land and factory will cost at a total of £8million and the land is acquired for £40000 which is not depreciable we assume all other equipment and materials are depreciable therefore £7.6million is depreciated over the lifetime of 20 years. The addition to depreciation will be 0.38 million per year.
An increase in staffing will cause the labor costs to increase by 50 % in real terms only in 2012, which are 50% of the Cost of Sales, with no further increase afterward. Material costs will increase in line with Sales which are 24% of the sales.
Since both of the projects have a positive NPV, therefore, we will select both of the projects if they are not mutually exclusive. The greatest uncertainty in the project lies within the growth rate and inflation rate since a minor change in them can cause the results obtained to be invalid. If the economy flatters, then the chances that the company will grow lower and can have profound consequences on the result of the company.
There could have been several other methods which we could have used to analyze the projects such as the payback method, Internal Rate of return method, and Profitability index. NPV and IRR are the most common methods of DCF and they have been extensively used by corporations to evaluate their capital projects. However, these methods are time-consuming and costly than other principle techniques. In many countries such as the United Kingdom, the Payback method has been given top priority by the corporate managers because of its ease of use and simplicity (Sangster, 1993). ...Download file to see next pagesRead More
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