An example of an investment appraisalWhizzos sell at £80 each with variable costs of £40 each. Lower Whizzo sales volumes
would not be expected to affect overhead costs, which are fixed.
6 The business’s corporation tax rate is 30 per cent and, to simplify matters, payment may
be assumed to fall due at the end of the year concerned.
7 The expenditure on the new machine would attract capital allowances at the rate of
25 per cent p.a. with any unrelieved expenditure being allowed on disposal.
8 All of the data given are expressed in current terms. Inflation is expected to run at about
5 per cent p.a. over the next decade. All of the relevant cash flows are expected to
increase at this annual rate.
9 The business’s after-tax cost of capital is (and is expected to remain at) 12 per cent p.a.
in money terms.
10 Working capital of £100,000 will be required from the start of the project and will be
returned at the end of year 5. This takes account of lost Whizzo sales.
On the basis of NPV should the project be undertaken or not?Assessment of Rapido project
Despite the fact that using a ‘real’ and a ‘money’ approach will give identical results if they
are correctly applied, in practice the money approach tends to be a lot easier to apply. We
shall, therefore, use the money approach.
In the assessment of the project our guiding principles must be:
l to identify the cash flows relevant to the decision (that is, differences between the cash
flows that will occur if the project is undertaken and those that will arise without the pro-
ject) and convert them into money terms;
l to identify the timing of those relevant cash flows; and
l to discover the NPV of the project by applying the adjustment for the time value of money
(in other words, discounting) to the relevant cash flows according to when it is anticipated
that they will occur.Annual operating cash flows£000
Sales revenue 2,000
Raw materials 600
Labour 600
Rent 40
Overheads 80
Contributions lost from Whizzo sales 400 (200 for years 3, 4 and 5)
1,720
Annual operating cash flow (in real terms) 280 (480 for years 3, 4 and 5)Notes
1 Depreciation.This is irrelevant, as it does not represent a cash flow.
2 Rent.The appropriate figure here is the rent from the subtenant should the project not go
ahead. Irrespective of the decision, both the rent of the entire site (of which £60,000 isSolution
‘