Question 2 b

The board have approached you to get your opinion of their expansion plan, which includes a chain of factory outlet stores. Below are the figures for the first one that is planned for a central Birmingham location next year.

Company policy dictates that any decision should be based on the results of calculating Net Present Value (NPV) of 3 years cash flows using a cost of capital of 12%, Payback Period (PBP) must be less than 3 years, and the Internal Rate of Return (IRR) of the project should provide a 5% cushion in case of increases in inflation or interest rates.

The investment consists of £105,000 for the land, building costs of £150,000 and £82,050 for fittings and equipment.

The cash flows in year 1 are expected to be: total sales revenue £620,100; the cost of cement products sold £164,195; metal stock sold £113,614; staff costs £25,523; light & heat £36,252; other overheads £138,951. The cash flows for the following years are the same, but are expected to increase by 2% inflation each year.

Requirements for Question 2 part (b)

Using the information above and in accord with the above stated company policy you are required to calculate:

i. Net Present Value (NPV)

ii. Payback period (PBP) and Discounted Payback Period (DPBP)

iii. Internal Rate of Return

iv. Based on your calculations do you recommend the investment is made and the new outlet store is built?

v. Critically discuss the limitations of the above project appraisal techniques used and any other recommendations to the board.