Impega plc is considering whether or not to undertake a one off project. The initial investment required is £150,000 but it also requires additional working capital of £30,000 to be made available at the same time as the initial investment. This working capital would be released at the end of the project. Writing Down Allowance (WDA) of 25% on a reducing balance basis is available for the initial investment. The allowance can first be claimed against the first year revenues (cash inflows) as the company has no other income to set the allowances against. As the company pays tax 1 year in arrears the tax saving will take place in the following year. The company expects pre tax cash inflows from the project to be £45,000 each year for the first 3 years and £60,000 for each of the following 2 years. At the end of the project there will be no scrap value. Impega has a cost of capital is 10% and pays Corporation Tax at a rate of 30%. Required (a) Calculate the project's net present value (NPV) and advise the company whether or not to proceed with the project. (b) Calculate IRR of the project. Use 15% discount rate as the second rate. (c) State the advantages and disadvantages of using internal rate of return (IRR) when evaluating investment projects.
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
Impega plc is considering whether or not to undertake a one off project. The initial investment required is £150,000 but it also requires additional working capital of £30,000 to be made available at the same time as the initial investment. This working capital would be released at the end of the project. Writing Down Allowance (WDA) of 25% on a reducing balance basis is available for the initial investment. The allowance can first be claimed against the first year revenues (
The company expects pre tax cash inflows from the project to be £45,000 each year for the first 3 years and £60,000 for each of the following 2 years. At the end of the project there will be no scrap value. Impega has a cost of capital is 10% and pays Corporation Tax at a rate of 30%.
Required
(a) Calculate the project's
(c) State the advantages and disadvantages of using
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