Ican 2024 Strategic Financial Management Question 2

The following draft appraisal of a proposed investment project has been prepared for the Finance Director of Keke Plc (KP) by a trainee accountant. The project is consistent with the current business operations of KP. Year 1 2 3 4 5 Sales (units/yr) 250,000 400,000 500,000 250,000 ₦000 ₦000 ₦000 ₦000 N000 Contribution 13,300 21,280 26,600 13,300 - Fixed costs (5,300) (5,618) (5,955) (6,312) - Depreciation (4,375) (4,375) (4,375) (4,375) - Interest payments (2,000) (2,000) (2,000) (2,000) - Taxable profit 1,625 9,287 14,270 613 Taxation - (488) (2,786) (4,281) (184) Profit after tax 1,625 8,799 11,484 (3,668) (184) Scrap value - - - 2,500 - After-tax cash flows 1,625 8,799 11,484 (1,168) (184) Discount at 10% 0.909 0.826 0.751 0.683 0.621 Present values 1,477 7,268 8,624 (798) (114) Net present value = (16,457,000 – 20,000,000) = ₦3,543,000 so reject the project. The following information was included with the draft investment appraisal: (1) The initial investment is ₦20 million. (2) Selling price: ₦120/unit (current price terms), selling price inflation is 5% per year. (3) Variable cost: ₦70/unit (current price terms), variable cost inflation is 4% per year. (4) Fixed overhead costs: ₦5,000,000/year (current price terms), fixed cost inflation is 6% per year. (5) ₦2,000,000/year of the fixed costs are development costs that have already been incurred and are being recovered by an annual charges to the project. (6) Investment financing is by a ₦20 million loan at a fixed interest rate of 10% per year. (7) Keke Plc can claim 25% reducing balance tax allowable depreciation on this investment and pays taxation one year in arrears at a rate of 30% per year. (8) The scrap value of machinery at the end of the four-year project is ₦2,500,000. (9) The real weighted average cost of capital of Keke is 7% per year. (10) The general rate of inflation is expected to be 4.7% per year.