Quantitative factors - numerical questions (2)
Question 1
The manager of O'Neill Biochemical Ltd is considering relocation of the processing facilities. He has narrowed down the choices to two options. Data relevant for this decision is as follows:
Location A
This location is in Michigan and, although a cheaper option, there would be higher operating costs due to the higher wages that would need to be offered to recruit suitable workers. The capital cost of plant A is $5 million.
Location B
This location is in Houston would be very near transport links, which would save the firm money, but the site is relatively expensive. The capital cost of plant B is $10 million.
Forecast information for each of the plants was produced as follows:
| Location A | Location A | Location B | Location B | |
|---|---|---|---|---|
| Revenue receipts | Operating payments | Revenue receipts | Operating payments | |
| $ million | $ million | $ million | $ million | |
| Year 1 | 7.3 | 4.0 | 7.3 | 2.7 |
| Year 2 | 7.5 | 5.2 | 7.5 | 3.3 |
| Year 3 | 9.1 | 5.3 | 9.1 | 4.6 |
| Year 4 | 9.8 | 6.5 | 9.8 | 5.5 |
| Year 5 | 11.2 | 8.1 | 11.2 | 6.4 |
Additional information:
- A modification to the plant at location B to treat the pollution would need an extra capital cost of $2 million. In addition, operating payments would increase in each year by $400,000.
- The company's cost of capital is 10% per annum.
- The following extract is from the present value table for $1 at 10% per annum.
| Year 1 | 0.909 |
|---|---|
| Year 2 | 0.826 |
| Year 3 | 0.751 |
| Year 4 | 0.683 |
| Year 5 | 0.621 |
Required
Produce net present value calculations for the locations A and B. For Location B provide figures both for the plant in its basic form and also with the modifications to treat pollution.
Question 2
Flanders Ltd is trying to decide which project should be taken up, out of three possible investments. The initial investment would amount to $40,000. Scrap value at the end of use would be nil.
The cost of capital is 9%, for which discount factors are as follows:
| Year | Present value of $1 |
|---|---|
| 1 | 0.917 |
| 2 | 0.842 |
| 3 | 0.772 |
| 4 | 0.708 |
| 5 | 0.650 |
The net cash inflows from the three projects under consideration are:
| XC1 | VB93 | IPR2 | |
|---|---|---|---|
| $ | $ | $ | |
| Year 1 | 5,000 | 14,000 | 11,000 |
| Year 2 | 8,000 | 16,000 | 12,000 |
| Year 3 | 6,000 | 21,000 | 13,000 |
| Year 4 | 12,000 | - | 14,000 |
| Year 5 | 18,000 | - | - |
Required
For each possible project you are required to calculate:
(i) Payback
(ii) Net present value
