Capital Project Management - Report Example

Name of Student Course Name of Instructor Due Date Capital Project Management Introduction Capital projects refer to those construction projects that promote the growth of a utility’s infrastructure or upgrade or reinstate the worn out infrastructure. These projects require a considerable amount of financial investment or capital. When they are completed, they are projected to service the utility and its customers for several years (Fight, 43). Hence, it is important that the delivery of project is realized. This assignment seeks to analyze a capital project at its preliminary phase. The assignment basically looks at the financial viability of the project in which case relevant computations of financial aspects of a project will be done. Capital Cost of the Project. Capital costs refer to costs that are realized during purchases. These include land, premises, construction and equipment procured in order to be employed in the production of goods or the provision of services (Fight, 47). In simple term capital cost is the overall cost required to move a project to a commercially functioning state. Nevertheless, capital costs are not narrowed to the preliminary construction of a manufacturing unit or other undertakings. For instance, the acquiring of a new device that will enhance production and have a long period of operation is a capital cost (Fight, 54). Additionally labor costs are not part of capital costs but construction labor is considered capital cost. It is vital to note that capital costs are expenses that are incurred only once but their payment may be stretched out for a given period of time in years as captured in financial statements and tax returns. The following are the capital costs for this particular project; Item Amount in £ The cost of major equipment in the tank farm 500,000 The cost of major equipment in the process area is 1,500,000 The total cost of installing the pipe rack 400,000 Additional capital requirement for support functions (25% of 2,400,000) 600,000 Total 3,000,000 Hence the total capital cost of this project is estimated to be £3 million; see attached excel spread sheet. Product Sale Price This is to be calculated in tonnes per year of production to achieve an internal rate of return of 30% over the ten years production life of the plant. Therefore, the basics of internal rate of returns will be highly useful in arriving at the exact sale price although this will not involve complex formulae and calculations. The basic concept is to consider all operational the cost incurred by the project per year and project a product sales price that will ensure an internal rate of return of 30% for the entire ten year operational period (Fight, 65). Total capital cost 3,000,000 Fixed cost Maintenance cost (2% of 2,000,000) 40,000 Insurance (1.5% of 2,000,000) 30,000 Wages and salaries 35,000 Indirect labor cost (40% of 35, 0000) 14,000 Total fixed Cost 119, 000 Variable cost Raw materials 2,500,000 Utilities 1,000,000 Miscellaneous 250,000 Packaging and shipping 900,000 Total Variable cost 4,650,000 Total Fixed and variable cost 4,769,000 Capital cost will be repaid for a period of ten years hence payment per year will be 300,000 bringing the total project cost per year to be £5,069,000. To realize an internal rate of return of 30%; [(Y-5069000)/5069000] x 100 = 30% When this is simplified and computed the value of Y is £5,084,207. This is thus the total product sales per year to realize IRR of 30% . This translates to £203.3 per ton. Break Even Point in Years. Breakeven point is arrived at by conducting a break even analysis. This is a computation of the volume of sales in a given units that is needed to merely cover costs (Fight, 88). When the volume of sales is low the result would be a loss while higher sales volume would lead to profitability. Therefore this analysis spotlights the correlation of fixed cost, cost per unit-variable cost, and selling price per unit (Fight, 89). Therefore, breakeven point for this project will be the point at which recovery of direct costs is realized, overhead costs have been engrossed and where profit commences. From economic and accounting perspective, the formula for arriving at a breakeven point is shown below; Break-Even Point = FC/(1-VC/S) Where: FC = Fixed Costs VC = Variable Costs S = Sales From the previous computation; Fixed Costs 119, 000 Variable Costs 4,650,000 Sales 5,069,000 Therefore, BEP= 119000/(1-4650000/5069000) BEP = 1,439,644.39 The projected was hence operated at 5,069,000/1,439,644.39 = 352% break even during the period. Net Present Value (NPV) for the Project Net present value abbreviated as NPV is the distinction between current value of cash inflows and the current value of cash outflows and the formula is as given below (Fight, 101). For this project, this formula will not be used but instead an excel spread sheet will be employed in determining the net present value as well as profitability for the project, and the prototype is as shown below; (the actual excel spread sheet is attached) The calculation on the spread sheet is based on the initial investment of 3 million euro and the project is envisaged to be generating an income of approximately 1.4 million euro every year. This value will be treated as the cash inflow or net income and the depreciation value of 0.2 million euro per year. The net present value at 15% rate is as shown below where by the initial invested amount is subtracted from the present value of the inflows gotten from the spread sheet. Rate 15%   £3,094,222.22 year 1 1400000 year 2 1600000 year 3 1800000 year 4 2000000 year 5 2200000 year 6 2400000 year 7 2600000 year 8 2800000 year 9 3000000 year 10 3200000     NPV 94,222.22 Number of Design resource required in subsequent phases Phases two and three of the project according to the timetable is envisaged to take 6 months. Six months has a total of 24 weeks and since working hours per week are 37.5, the total number of hours worked for 24 weeks (six months) will be; 24 x 37.5 = 900 Average cost per hour is estimated at £75 Therefore, to obtain the approximate number of design resources the average cost per hour will be multiplied by number of hours worked for the six months duration; Design resources = 900 x 75 = £67,500 The Project’s Corporation Tax Liability In the fourth year of production, the project will be generating an inflow of 2million euro with a profitability index of 1.5 %. This indicates that the project will have generated a profit before tax of: (1.5 x 5,069,000) – 5,069,000 = 2,534,500 Corporation tax liability at 26% is 0.26 x 2,534,500 = 658 970 Summary Answer Sheet Requirement Answer Total Capital Cost of Project £ 3,000,000 Sales Price First Production Year £ 5,084,207 Break-even point Years 1,439,644.39 NPV at discount rate of 15%, £ 94,222.22 Design resource required Number of people 67,500 Tax liability fourth production year £ 658 970 Total 10,344,543.61 Works Cited Fight, Andrew. Introduction to Project Finance. Oxford: Butterworth Heinemann, 2006. Print. Read More

 

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