You are a Corporate Finance Manager at Penguins plc, a leading operator of domestic waste recycling and incineration services in London, UK.New legislation on air quality and emissions control means that the company must invest in new incineration facilities. Two possible investment options have been identified. Each option has an expected life of ten years. Sufficient funding is available to finance only one of the options. Option AOption B £000£000Initial cost (year 0)200,250210,260Scrap value (year 10)310425 Forecast net cash inflow Year 14000060000Year 25000045000Year 34500050000Year 45000050000Year 55500050000Year 65000040000Year 74500040000Year 84000035000Year 94000030000Year 103500030000 Assume that all cash flows occur at the end of the respective year. Penguins plc has a cost of capital of 16 per cent.Required: Calculate the net present value of option A and option B. Use Penguins plc’s cost of capital as the discount rate.Critically evaluate the net present value technique.

Net present value Present value of cash inflows less present value of cash outflows

Answered: You are a Corporate Finance Manager at…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter10: Capital Budgeting: Decision Criteria And Real Option

Section: Chapter Questions

Problem 4P

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You are a Corporate Finance Manager at Penguins plc, a leading operator of domestic waste recycling and incineration services in London, UK.

New legislation on air quality and emissions control means that the company must invest in new incineration facilities. Two possible investment options have been identified. Each option has an expected life of ten years. Sufficient funding is available to finance only one of the options.

	Option A	Option B
	£000	£000
Initial cost (year 0)	200,250	210,260
Scrap value (year 10)	310	425

Forecast net cash inflow
Year 1	40000	60000
Year 2	50000	45000
Year 3	45000	50000
Year 4	50000	50000
Year 5	55000	50000
Year 6	50000	40000
Year 7	45000	40000
Year 8	40000	35000
Year 9	40000	30000
Year 10	35000	30000

Assume that all cash flows occur at the end of the respective year. Penguins plc has a cost of capital of 16 per cent.

Required:

Calculate the net present value of option A and option B. Use Penguins plc’s cost of capital as the discount rate.
Critically evaluate the net present value technique.

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