INVESTMENT APPRAISAL

a. Yehowa Da Company Ltd is considering investing in an ice cream plant to operate for
the next four years. The plant will cost GHC5,000 and is expected to have no residual
value.
Capital Allowance, at a rate of 20% per annum will be available in respect of the
expenditure. Revenue from the plant will be GHC7,000 per year for the first two years
and GHC5,000 thereafter. Incremental costs will be GHC4,000 per annum throughout the
period.
The companys cost of capital is 10% and pays corporate tax at 28% to the year. Cash
flows will be received or paid in the year in which they relate.

Required:
i. Calculate the tax saved through the capital allowance and show the savings arise.
(3 marks)
ii. Advise Yehowa Da Company Ltd on whether or not to proceed with the

investment in the ice cream plant. (4

marks)
(Total: 20 marks)

STC Ltd, which recently entered the express parcel delivery business, is evaluating a new venture; the
establishment of a motorcycle courier service offering same-day delivery.

The venture would require the purchase of a building for 250 million, payable immediately. The
building would need extensive alterations costing 150 million to enable it to become the control and
distribution centre for the venture. The alterations would take a year, and operations could not
commence until the building was ready. Immediately after completion of the building, STC Ltd would
take delivery of 100 motorcycles at 4 million each and engage riders.

Running costs of the operation in current prices are expected to be fixed costs of 750 million per annum
and a variable cost of 1000 per packet. Fixed costs are expected to increase by 8% per year and
variable costs by 5% per year. 50 million of working capital would need to be injected immediately
prior to the completion of the building.
A market research, undertaken at a cost of 40 million, suggests that the price per packet should be
5,000 or 8,000. At these prices the following numbers of packets are forecast:

Expected Packets Per Year

Probability of Demand Price of 5000 Price of 8000

0.10 175,000 160,000

0.20 275,000 190,000
0.40 350,000 210,000
0.20 375,000 230,000
0.10 400,000 260,000

The above prices are at current price levels and are expected to increase by 5% at the end of each year.
Over the next 5 years, STC Ltds cost of capital is expected to be 15% per annum, constant. The board
wishes to evaluate the venture over the first five years of operations, at the end of which the realizable
value of the venture as a going concern is expected to be 1 billion.

Unless otherwise stated, assume all cash flows take place at the end of the year. Ignore taxation.

Required:

(a) Decide, with reasons, which price for the packets would maximize profit. (6 marks)

(b) Calculate the expected net present value of the venture for the first five years of operations.

(14marks)

(Total:20marks)

A research project, which to date has cost the company $150,000, is under
review.
If the project is allowed to proceed, it will be completed in approximately
one year,
when the results would be sold to a government agency for $200,000.
The managing director estimates that the following resources are necessary
to
complete the project:
Materials: These have just been purchased at a cost of $60,000. The
materials
are toxic and, if not used in this project, must be disposed of at a cost of
$5,000.
Skilled labour: Four skilled workers are paid $35,000 per year each for 230
working days a year. They are currently working at 85% capacity. The
project is
expected to require an additional 115 days to complete it.
Overheads: Company policy is to absorb overheads at 120% of labour cost.
Research staff: The decision already has been made that, when work on
this
project ceases, the research department will be closed. Research wages for
the
year are $60,000, and redundancy and severance pay has been estimated at
$15,000 now or $35,000 in one year's time.
Equipment: The project utilises a special microscope, which cost $18,000
three
years ago. It has a residual value of $3,000 in another two years and a
current
disposal value of $8,000. If used in the project it is estimated that the
disposal
value in a year's time will be $6,000.
Share of general building services: The project is to be charged with
$35,000
per year to cover general building expenses. If the project is discontinued,
the
space occupied could be sub-let for an annual rental of $7,000.
Required:
Advise the managing director whether the project should be allowed
to proceed, explaining the reasons for the treatment of each item.
(Ignore the time value of money.)
S