Problem
Marissa owns a bakery in Bangsar, she is evaluating expanding her business in Kajang. Hamizah, the company's manager, has just finished her analysis of the new branch. She has estimated that the new branch could attract new potential customers for the next 9 years given the strategic location of the new shop. Sarina the financial analyst of the company has been asked by Marissa to perform an analysis of the new branch and present her recommendation on whether the company should open a new branch. Sarina has used the estimate provided by Marissa to determine the revenues that could be expected from the new branch. She has also expected the expense of opening the new branch and the annual operating expenses. If the company opens a new branch, it will cost RM450 million today and it will have a cash outflow of RM 55 million 10 years from today in costs associated with the liquidation of the new branch. The expected cash flow each year from the new branch is shown in the table. Marissa's bakery has a 14% required rate of return on all its bakery products.
|
Year
|
Cash Flow
|
|
0
|
-450,000,000
|
|
1
|
30,000,000
|
|
2
|
60,000,000
|
|
3
|
90,000,000
|
|
4
|
100,000,000
|
|
5
|
150,000,000
|
|
6
|
45,000,000
|
|
7
|
25,000,000
|
|
8
|
34,000,000
|
|
9
|
23,500,000
|
i. Based on your analysis, should the company expand and open a new branch?
ii. Under what circumstances will the IRR and NPV rules lead to the same accept-reject decisions? When might they conflict?
iii. If NPV is conceptually the best procedure for capital budgeting, why do you think multiple measures are used in practice?