Ican 2022 Strategic Financial Management Question 3

Opeyemi operates in an economy that has almost zero inflation. Management ignores inflation when evaluating investment projects because it is very low and considered insignificant. Opeyemi is evaluating a number of similar, alternative investments. The company uses an after tax cost of capital of 6% and has already completed the evaluation of two investments. The third investment is a new product that would be produced on a just-in-time basis and is expected to have a life of three years. This investment requires an immediate cash outflow of N200,000, which does not qualify for tax depreciation. The expected residual value at the end of the project’s life is N50,000. A draft financial statement showing the values that are specific to this investment for the three years is as follows: Year 1 Year 2 Year 3 N N N Sales 230,000 350,000 270,000 Production costs: Materials 54,000 102,000 66,000 Labour 60,000 80,000 70,000 Other* 80,000 90,000 80,000 Profit 36,000 78,000 54,000 Closing receivables 20,000 30,000 25,000 Closing payables 6,000 9,000 8,000 *Other production costs shown above include depreciation calculated using the straight line method. The company is liable to pay corporate tax at a rate of 30% of its profits. One half of this is payable in the same year as the profit is earned, the remainder is payable in the following year.