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
Difference between Debtcapital and Equity capital Debtcapital comprises: Long-term loans (debentures, loan stock etc.) Preference share capital May also in

An average should be: (a) vigorously defined, (b) easy to compute, (c) capable of simple interpretation, (d) dependent on all the observed values, (e) not unduly influenced by one

Cost of Equity Share Capital (ke) The cost of equity capital is the 'maximum rate of return that the Co. must earn on equity financed portion of its investments in order to go

What are the Objectives or goals of Financial Management? Objectives of Financial Management: - It is the responsibility of the top management to lay down the objectives or goa

Two companies are identical in all aspects except in the debt-equity profile. Company X has 14% debentures worth Rs. 25,00,000 whereas company Y does not have any debt. Both compan

What is the common pattern of cash flows for a share of preferred stock? How does the market define the value of a share of preferred stock, specified these promised cash flows?

A. Joe wants to invest in Nebraska Municipal 6% GOB that are rated AA. Joe's tax rate is usually between 28% .  GE plans to sell AA rated 8% coupon bonds. Compute Joe's after-tax i

The price volatility properties of bonds with the help of the graph of the price/yield relationship. Let us now, with the help of a graph, illustrate how duration estim

What are the main classes of institutions that issue bonds in the USA? There are three major classes of institutions which issue bonds in the USA: national governments, local g

What is Rationale and behind profitability maximisation Rationale & behind profitability maximisation, as a guide to financial decision making, is simple. Profit is a test of e