Page 89 - FM Integrated WorkBook STUDENT 2018-19

Investment appraisal – Further aspects of discounted cash flows

Question 11

Full NPV question

Larson Co is considering a potential project with the following forecasts:

Now T1 T2 T3

Initial investment ($million) (2,500)
Disposal proceeds ($million) 700
Demand (millions of units) 8 12 4

The initial investment will be made on the first day of the new accounting period.

The selling price per unit is expected to be $225 and the variable cost $85 per
unit. Both of these figures are given in today’s terms.

Tax is paid at 30%, one year after the accounting period concerned.

Working capital will be required equal to 10% of annual sales. This will need to
be in place at the start of each year.

Tax-allowable depreciation is available at 25% reducing balance.

The company has a real required rate of return of 7.7%.

General inflation is predicted to be 4% pa but the selling price is expected to
inflate at 3% and variable costs by 6% pa

Determine the NPV of the project.

N.B. work in $ millions and round all numbers to the nearest whole million.

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