Report – Word Count – 3000 words

Question 1

In the light of a range of investment appraisal methods and the modern business requirement to allocate resources appropriately, it is generally considered that the key factors needed to be considered by an organisation are:

a) Risk, return and liquidity

b) The length of the project

c) Data sources

d) Investment size

e) The economic market and environment

f) Qualitative and Quantitative influences

a) Explain how investment appraisal techniques, such as Internal Rate of Return, Net Present Value and Payback Period, use these factors to achieve the corporate goals of the business. (15 marks)

b) A company has a £5million cash surplus which it considers is free to be invested for a maximum period of six years.

Evaluate the risk, return and liquidity of each of the following investment options:

i. Long-term fixed rate deposit account

ii. Government securities (Gilts)

iii. Shares in a public limited company (10marks)

**Question 2**

The manager of Mere Ltd has been investigating the purchase of an automated quality control line that would eliminate the need for number of employees. The purchase and installation of the new equipment would be £600,000.

This is next year’s forecast operational statement of profit or loss, assuming current working

practices and production of 1,000,000 units

| £000 |

Sales | 1,200 |

Less: Variable material cost | (300) |

Variable labour cost | (250) |

Contribution | 650 |

Less: Fixed production costs | (100) |

Fixed administration costs | (300) |

Operating Profit | 250 |

Should the automated quality control line be installed:

- Labour costs would reduce to £90,000 per year, regardless of the production level
- Fixed production costs will increase by £20,000 per year.
- All other costs will remain unchanged

The company’s cost of capital is 5% and the discount factors over the five year life of the project are:

Year 0: 1.00; Year 1: 0.952; Year 2: 0.907; Year 3: 0.864; Year 4: 0.823; Year 5: 0.784

The automated line would be paid for immediately and have no value at the end of the five year project. Assuming that sales and costs remain at the same level for each of the five years and occur at the end of each year, calculate the net present value of the project.

Explain ways in which the directors of Mere Ltd can be encouraged to achieve the strategic objective of maximisation of shareholder wealth using managerial reward schemes and how these schemes can conflict with shareholder wealth maximisation. (10 marks)

**Question 3**

ABC LTD is considering a new investment which would start immediately and last four years. The company has gathered the following information:

Asset cost – £160,000

- Annual sales are expected to be 30,000 units in Years 1 and 2 and will then fall by 5,000 units per year in both Years 3 and 4.
- The selling price in first-year terms is expected to be £4.40 per unit and this is then expected to inflate by 3% per annum.
- The variable costs are expected to be £0.70 per unit in current terms and the incremental fixed costs in the first year are expected to be £0.30 per unit in current terms. Both of these costs are expected to inflate at 5% per annum.
- The asset is expected to have a residual value (RV) of £40,000 in money terms.
- The project will require working capital investment equal to 10% of the expected sales revenue. This investment must be in place at the start of each year.
- Corporation tax is 30% per annum and is paid one year in arrears.
- General inflation is 4% and the real cost of capital is 7.7%

**Required:**

Calculate the net present value of the investment project and comment on its financial acceptability.

Explain the Fisher effect theory and its impact on capital investment decisions (10 Marks).

**Question 4**

Mobile Technology Ltd is considering developing a new phone that can be used by online advertisers and suppliers. The following data has been collected regarding the new product.

Development Costs (including creating prototypes) are expected to be £2,500,000 in year 0 and year 1.

Production and Sales are planned as follows:

Year | Production | Sales |

2 | 20,000 | 0 |

3 | 30,000 | 40,000 |

4 | 40,000 | 40,000 |

5 | 0 | 10,000 |

Variable costs of production are budgeted at £450 per unit with Fixed production costs being budgeted at £2,000,000 for each of years 2 – 4.

Selling prices are planned at £750 per unit for sales in years 3 and 4, reducing to £600 per unit in year 5.

No production or sales are expected after year 5.

The company’s cost of capital is 10% and this is reflected in the following discount factors:

Year 0 1 2 3 4 5

10% Discount Factors 1.000 0.909 0.826 0.751 0.683 0.621

**Required:**

Calculate both the non-discounted and discounted life-cycle cash flows for the product.

Explains the difference between the net present value arising from the product and the non-discounted cash flow and highlight key risks associated with the plan.

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