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
Market based Ratio's   PE:           The Price-to-Earnings ratio is calculated by market price per share to earnings per share and is expressed in terms of times. It shows h

Brandon Michael Chu of Henry Law & Yang Yi Capital Limited believes that earnings and dividends at Alua Amanova & Shuwen Wang Technologies (AST) will continue to grow at 12% per ye

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

a) The combined two-firm concentration ratio of Motorola (approximately 17.5%) and Nokia (35%) is around 52.5% of the market. b) Up to 2 marks for correct definition: Market sha

DIY Inc. plans to raise $200,000 with a right offering. The current stock price is $100 and there are 80,000 shares outstanding. a. If DIY sets the subscription price to be $80

Ho can we estimate that firm is going to benefit from projec To calculate how firm is going to benefit from project we need to calculate whether firm is earning the required ra

what is the annual tax shield to a firm that has total assets of $80 million and a net worth of $55 million,if the average interest rate on debt is 8.5% and the marginal tax rate i

The volatility assumption has a great influence on the arbitrage free value of the bond. The higher the expected volatility, the greater the value of an option. W

Exchange Requirements To ensure money supply, some central banks require some or all of its foreign exchange receipts (generally from exports) be exchanged for the local curren

Q. What are the benefits as well as costs of holding inventory? What is Inventory? What are the benefits as well as costs of holding inventory? Ans. Inventory: - Every enter