Exam Standard Question
Sleet plc is preparing its capital budget and is considering four projects. Financial details of these projects are as follows.
|
|
Project A
|
Project B
|
Project C
|
|
Initial investment
|
£750,000
|
£800,000
|
£900,000
|
|
Net present value
|
£370,000
|
£430,000
|
£400,000
|
These three projects are divisible and cannot be deferred or repeated.
Project D
This is an essential investment in equipment to purify the toxic waste of Sleet plc. An initial investment of £1,000,000 is expected to lead to savings by avoiding fines and waste disposal costs. Forecast annual volumes of toxic waste are as follows:
|
Year
|
1
|
2
|
3
|
4
|
|
Volume (units)
|
15,000
|
18,000
|
21,600
|
25,900
|
Savings will be £20 per processed unit. Fixed operating costs will be £53,000 per year and variable operating costs will be £1 per processed unit. These values do not take account of anticipated inflation of 4% per year in savings and 5% per year in both fixed and variable operating costs.
Other information
The directors of Sleet plc have decided that capital investment funds will be limited to £3,000,000. They have agreed that Project D is essential and must be undertaken. Sleet plc has a nominal (money) cost of capital of 10%.
Required:
(a) Calculate the net present value of Project D and comment on your findings.
(b) Determine the best way for Sleet plc to invest the available capital investment funds and prepare an optimum investment schedule for the company.
(c) Discuss the reasons why capital investment funds may be rationed.
(d) Describe the limitations of accounting rate of return as an investment appraisal method.