Net present value of of the investment, Financial Management

Air Manchester (AM) is a new airplane manufacturer. It is considering investing in a software package, e.g. SAS, which would make its daily operations more efficient. The package costs £50,000. If the company buys the package, this will lead to yearly cost savings (prior to taxes and depreciation) of £20,000 during 4 years. The package has an economic lifetime of 4 years, and has no value at the end of its lifetime. It is depreciated according to the straightDline depreciation method (i.e. an equal amount is depreciated each year).

Prior to making the investment, AM needs to conduct some additional tests to assess the productivity and usability of the IT package. These tests will be performed by a specialised consultant that charges £4,000 (to be paid at time t=0). Five years ago the company has also spent £5,000 on a software system that will be discontinued when the new system is implemented. Moreover, the company needs to add net working capital of £1,000 immediately. This working capital can be recovered in full at the end of the software life.

The tax rate is 40% and the nominal discount rate for the investment is 10%. The yearly inflation rate is 2%. Consider initially that the entire project is financed with equity.

(a) Should AM proceed with the investment? Please provide calculations to motivate your answer.

(b) A senior executive of AM argues that this investment should be evaluated by looking at its payback period. How would you explain him/her the shortcoming of using payback period instead of NPV? Illustrate your answer using this specific investment case (i.e., use relevant figures for AM to illustrate your point).

(c) Would your results differ had you used real rather than nominal values? Why (not)? You don't need to reDdo the calculations, just provide a motivation for your answer.

(d) We assume in this problem that the new software is entirely financed by equity. Assume now that the software is partly financed by debt. Would the NPV of the investment increase or decrease, everything else equal? Justify your answer (you don't need to present the calculations, just comment on how the change in financing would affect NPV).

Posted Date: 3/15/2013 3:19:26 AM | Location : United States

Related Discussions:- Net present value of of the investment, Assignment Help, Ask Question on Net present value of of the investment, Get Answer, Expert's Help, Net present value of of the investment Discussions

Write discussion on Net present value of of the investment
Your posts are moderated
Related Questions
Discuss the implications of the interest rate parity for the exchange rate determination. Answer: Presume that the forward exchange rate is roughly an unbiased predictor of the

To what extent does empirical evidence on corporate objectives support the predictions of Baumol’s “Sales Maximisation Hypothesis?”

Techiniques of capm Effects of capm

Cascade Water Company (CWC) currently has 30 000 shares of common stock outstanding, trading at a price of R42 per share. CWC also has 500 000 bonds outstanding that are currently

I need a report on the topic Inventory Turnover Ratio. Can you please assist me for Inventory Turnover Ratio report for about 2500 words?

Incremental Cost The measured change in a firm's cost of production due to an additional activity pursued by the firm. Incremental costs can be measured by the cost difference

You know that Treasury bills have a beta of 0 because they are risk-free.  A portfolio of technology stocks has a beta of 3.  You plan to invest 40% of your investment capital in T

Functions of Financial Manager: - The financial manager is a associate of top management. He is intimately associated with the formulation of financial policies as well as financia

Roxanne invested $560,000 in a new business 7 years ago. The business was expected to bring in $8,000 each month for the next 26 years (in excess of all costs). The annual cost of

Analytical procedures of auditors Auditors must apply analytical procedures at the planning and overall review stage of audit. Analytical procedures include the considerati