Assignment
Salam Ltd Company currently sends out its vehicles for painting to specialist firms. During the last financial year, the number of vehicles painted was 796 at a cost of £224,472. You are considering the possibility of this work being undertaken by the company in a workshop set up for this purpose. The following information relates to the project:
• The paint shop can be set up in an existing building that has not been used for some years and is estimated to be worth £250,000.
• Equipment costing £480,000 needs to be purchased with a life expectancy of 6 years. The residual value is estimated as £96,000 at the end of year 6.
• The annual costs in today's money of the operation are estimated to be:
|
Rates and maintenance
|
£17,920
|
|
Management
|
£21,400
|
|
Labour
|
£46,970
|
|
Head office costs
|
£25,000
|
1. Based on the number of vehicles painted last year, the cost of consumable materials and other variable costs is estimated at £30,248 based on the number of vehicles painted last year.
2. Tax will be recoverable in year 2 and payable thereafter as shown below:
|
Year 2
|
£25,220
|
Recoverable
|
|
Year 3
|
£10,780
|
Payable
|
|
Year 4
|
£16,180
|
Payable
|
|
Year 5
|
£20,230
|
Payable
|
|
Year 6
|
£23,268
|
Payable
|
|
Year 7
|
£46,049
|
Payable
|
The head office costs are a re-allocation of existing overheads.
Task
1. Calculate the following performance indicators relating to the proposal:
2. NPV based on a cost of capital of 12%.
3. IRR.
4. Payback period in both nominal and present-value terms?
5. Do these indicators suggest that the project should be undertaken?
6. What other considerations should be taken into account by Salam Ltd Company when establishing the new project?
7. Assume that Salam Ltd Company typically adds or subtracts 4 percentage points to the overall cost of capital to adjust for risk. Should the new project be accepted?
8. The company's management is unsure of the reliability of the estimated figures for either the residual value of equipment or the unit variable cost. What is the maximum deviation allowed for the original decision to remain unchanged in each of the independent situations described below? Prove your answer.
9. The residual value of equipment if the change will affect only the residual value of the equipment.
10. The cost of consumable materials and other variable costs if the change will affect only the materials and other variable costs of the vehicles to be painted by the new project.