Henning Ltd is involved in the manufacture of pharmaceutical products and is currently considering an investment in a new production facility. The proposal would involve an initial investment in capital assets of £1,500,000 and projected increased annual sales revenues as a result of the investment would be as follows: Year Sales 1 £2,500,000 2 £2,625,000 3 £2,700,000 4 £2,500,000 5 £2,250,000 Variable costs amount to 50% of sales value. Annual fixed overheads as a result of the investment will amount to £680,000. This figure excludes depreciation, but does include an allocation of general overheads, which are not expected to increase as a result of undertaking this project, amounting to £20,000 per annum. The capital assets will be depreciated on a straight line basis over the five years assuming a nil residual value. The company expects to incur training and development expenses of £50,000 in the first year and £20,000 per year thereafter. The company estimates that an additional investment of £50,000 in working capital will be required and it is estimated that 80% of this would be recoverable at the end of 5 years. The company’s cost of capital is estimated to be 14% and Henning Ltd normally seeks a payback on investment within 4 years. Required: (a) Calculate each of the following for the investment proposal: (i) The net present value for the project. (ii) The payback period. (Include working capital requirement as part of the initial investment)

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter14: Capital Structure Management In Practice

Section14.A: Breakeven Analysis

Problem 8P

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Henning Ltd is involved in the manufacture of pharmaceutical products and is currently considering an investment in a new production facility. The proposal would involve an initial investment in capital assets of £1,500,000 and projected increased annual sales revenues as a result of the investment would be as follows: Year Sales 1 £2,500,000 2 £2,625,000 3 £2,700,000 4 £2,500,000 5 £2,250,000 Variable costs amount to 50% of sales value. Annual fixed overheads as a result of the investment will amount to £680,000. This figure excludes depreciation, but does include an allocation of general overheads, which are not expected to increase as a result of undertaking this project, amounting to £20,000 per annum. The capital assets will be depreciated on a straight line basis over the five years assuming a nil residual value. The company expects to incur training and development expenses of £50,000 in the first year and £20,000 per year thereafter. The company estimates that an additional investment of £50,000 in working capital will be required and it is estimated that 80% of this would be recoverable at the end of 5 years. The company’s cost of capital is estimated to be 14% and Henning Ltd normally seeks a payback on investment within 4 years. Required: (a) Calculate each of the following for the investment proposal: (i) The net present value for the project. (ii) The payback period. (Include working capital requirement as part of the initial investment)

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