Business Finance - BAFI3184
Added on 2020-09-17
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Business Finance - BAFI3184Investment SelectionAbstractEmploying a variety of capital investment evaluation techniques, including the Net Present Valuemethod, Internal Rate of Return, Payback Period method and Annualized Net Present Value (Equivalent Annual Amount) to select the investment best suited for the company. I.List sunk costs, side effects and opportunity costs for each capital investment project and calculate the Net Cash Flows for each project. Aura Investment is considering two projects in order to generate more profits for 20 to 25 years from the time of the investment. New investment will replace firm’s current investment and is expected to account for most of the firm’s profit.Two investment projects are:-10-storey hotel apartment building in the heart of London, United Kingdom-15-storey hotel apartment building next to the beach in Da Nang, Vietnam.Sunk costs: are unavoidable and unrecovered costs, which incurred in the past and have no influence on any ongoing projects in the future. (Kenton, 2018)10-storey building London15-storey building Da NangSunk costs$1,000,000 on market research Side-effectsof a capital investment project include ‘both positive (benefits) and negative (costs) cash flows which result to other aspects of the business as a result of taking on current business’ 10-storey building London15-storey building Da Nang
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Side-effects costsAdditional costs for maintenanceCarpet: $100,000Equipment: $200,000Swimming pools: $50,000Total $350,000(These costs are expected to increase5% per year)Additional costs for maintenanceCarpet: $75,000Equipment: $150,00Swimming pools: $30,000Total $255,000(These costs are expected to increase6% per year).Additional wage costs:$700,000 per year (Wages are expected to rise 3.00% per year for all staffs)Reduction wage costs:$350,000 per year (Wages are expected to rise 4.00% per year for all staffs)Opportunitycosts: are the benefits that individuals, investors or businesses have to give up when they have to select one investment project over another one. (Kenton 2018)10-storey building London15-storey building Da NangOpportunity costsA forgone revenue of $5,000,000 per year from the current investmentNet Cash Flows for each investment-Calculation of depreciation: Aura Investment used straight-line depreciation methodfor tax purposes. According to Larson (n.d.), companies depreciate their property such as apartment buildings so as to create an annual deduction. This will lead to a reduction in net income, therefore, reducing the amount of tax payment. Investment 1: 10-storey hotel apartment building in the heart of London, United Kingdom2
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Summary tableInformationNotesProject cost100,000,000.00$ Sold price120,000,000.00$ Sell after 20 yearsBook value-$ Revenue9,000,000.00$ Increase of 5% per year for the next 20 yearsTotal additional costs for maintenance350,000.00$ Rise 5% per yearCarpet100,000.00$ Equipment200,000.00$ Swimming pools50,000.00$ Staffs wage700,000.00$ Rise 3% per yearWorking capital 1,000,000.00$ Required rate of return13%Tax rate35%Table 1. Summary information of London investment-Depreciation = CostpriceNumberofyearsDepreciationUsing Straightline Depreciation methodCost price100,000,000.00$ Years of life20Depreciation5,000,000.00$ Table 2. Depreciation of London investment-Gain/Loss on SaleGain/loss on SaleBook value at year 0 5,000,000.00$ Salvage value at year 080,000,000.00$ Gain on Sale75,000,000.00$ Table 3. Gain/Loss on Sale of old investmentGain/Loss on SaleBook value at year 20-$ Salvage value at year 20120,000,000.00$ Gain on Sale120,000,000.00$ 3
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Table 4. Gain/Loss on Sale of London investment-Incremental revenue = Revenue in the expected project - Revenue of current investment-Incremental wage cost = Wage cost of the expected project - Wage cost of current investment(Calculation of Profit and Loss and Net Cash Flows are performed in Excel Worksheets)Profit and Loss statementYear0123456789Incremental cash revenue4,000,000.00$ 4,450,000.00$ 4,922,500.00$ 5,418,625.00$ 5,939,556.25$ 6,486,534.06$ 7,060,860.77$ 7,663,903.80$ 8,297,098.99$ Gain/loss on Sale75,000,000.00$ Incremental costs for maintenance(350,000.00)$ (367,500.00)$ (385,875.00)$ (405,168.75)$ (425,427.19)$ (446,698.55)$ (469,033.47)$ (492,485.15)$ (517,109.41)$ Incremental wage cost(300,000.00)$ (301,000.00)$ (301,630.00)$ (301,858.90)$ (301,653.67)$ (300,979.23)$ (299,798.35)$ (298,071.54)$ (295,756.88)$ Depreciation cost(5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ Taxable income75,000,000.00$ (1,650,000.00)$ (1,218,500.00)$ (765,005.00)$ (288,402.65)$ 212,475.40$ 738,856.29$ 1,292,028.94$ 1,873,347.12$ 2,484,232.71$ Tax paid (35%)(26,250,000.00)$ 577,500.00$ 426,475.00$ 267,751.75$ 100,940.93$ (74,366.39)$ (258,599.70)$ (452,210.13)$ (655,671.49)$ (869,481.45)$ Income after tax48,750,000.00$ (1,072,500.00)$ (792,025.00)$ (497,253.25)$ (187,461.72)$ 138,109.01$ 480,256.59$ 839,818.81$ 1,217,675.63$ 1,614,751.26$ Profit and Loss statementYear1011121314151617181920Incremental cash revenue8,961,953.94$ 9,660,051.64$ 10,393,054.22$11,162,706.93$11,970,842.28$12,819,384.39$13,710,353.61$14,645,871.30$15,628,164.86$16,659,573.10$17,742,551.76$ Gain/loss on Sale120,000,000.00$Incremental costs for maintenance(542,964.88)$ (570,113.12)$ (598,618.78)$ (628,549.71)$ (659,977.20)$ (692,976.06)$ (727,624.86)$ (764,006.11)$ (802,206.41)$ (842,316.73)$ (884,432.57)$ Incremental wage cost(292,809.94)$ (289,183.61)$ (284,827.97)$ (279,690.09)$ (273,713.94)$ (266,840.17)$ (259,005.92)$ (250,144.67)$ (240,186.02)$ (229,055.45)$ (216,674.16)$ Depreciation cost(5,000,000.00)$(5,000,000.00)$(5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ (5,000,000.00)$ Taxable income3,126,179.13$ 3,800,754.91$ 4,509,607.48$ 5,254,467.13$ 6,037,151.14$ 6,859,568.17$ 7,723,722.83$ 8,631,720.52$ 9,585,772.43$ 10,588,200.92$131,641,445.03$Tax paid (35%)(1,094,162.69)$(1,330,264.22)$(1,578,362.62)$ (1,839,063.50)$ (2,113,002.90)$ (2,400,848.86)$ (2,703,302.99)$ (3,021,102.18)$ (3,355,020.35)$ (3,705,870.32)$ (46,074,505.76)$ Income after tax2,032,016.43$ 2,470,490.69$ 2,931,244.86$ 3,415,403.63$ 3,924,148.24$ 4,458,719.31$ 5,020,419.84$ 5,610,618.34$ 6,230,752.08$ 6,882,330.60$ 85,566,939.27$ Table 5. Profit and Loss Statement of London investment4
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Cash flow statementYear0123456789Tax paid (35%)(26,250,000.00)$ 577,500.00$ 426,475.00$ 267,751.75$ 100,940.93$ (74,366.39)$ (258,599.70)$ (452,210.13)$ (655,671.49)$ (869,481.45)$ Incremental cash revenue4,000,000.00$ 4,450,000.00$ 4,922,500.00$ 5,418,625.00$ 5,939,556.25$ 6,486,534.06$ 7,060,860.77$ 7,663,903.80$ 8,297,098.99$ Incremental costs for maintenance(350,000.00)$ (367,500.00)$ (385,875.00)$ (405,168.75)$ (425,427.19)$ (446,698.55)$ (469,033.47)$ (492,485.15)$ (517,109.41)$ Incremental wage cost(300,000.00)$ (301,000.00)$ (301,630.00)$ (301,858.90)$ (301,653.67)$ (300,979.23)$ (299,798.35)$ (298,071.54)$ (295,756.88)$ Salvage value80,000,000.00$ Initial Outlay(100,000,000.00)$ Working capital(1,000,000.00)$ Net cash flows(47,250,000.00)$ 3,927,500.00$ 4,207,975.00$ 4,502,746.75$ 4,812,538.28$ 5,138,109.01$ 5,480,256.59$ 5,839,818.81$ 6,217,675.63$ 6,614,751.26$ Cash flow statementYear1011121314151617181920Tax paid (35%)(1,094,162.69)$(1,330,264.22)$(1,578,362.62)$ (1,839,063.50)$ (2,113,002.90)$ (2,400,848.86)$ (2,703,302.99)$ (3,021,102.18)$ (3,355,020.35)$ (3,705,870.32)$ (46,074,505.76)$ Incremental cash revenue8,961,953.94$ 9,660,051.64$ 10,393,054.22$11,162,706.93$11,970,842.28$12,819,384.39$13,710,353.61$14,645,871.30$15,628,164.86$16,659,573.10$17,742,551.76$ Incremental costs for maintenance(542,964.88)$ (570,113.12)$ (598,618.78)$ (628,549.71)$ (659,977.20)$ (692,976.06)$ (727,624.86)$ (764,006.11)$ (802,206.41)$ (842,316.73)$ (884,432.57)$ Incremental wage cost(292,809.94)$ (289,183.61)$ (284,827.97)$ (279,690.09)$ (273,713.94)$ (266,840.17)$ (259,005.92)$ (250,144.67)$ (240,186.02)$ (229,055.45)$ (216,674.16)$ Salvage value120,000,000.00$Initial OutlayWorking capital1,000,000.00$ Net cash flows7,032,016.43$ 7,470,490.69$ 7,931,244.86$ 8,415,403.63$ 8,924,148.24$ 9,458,719.31$ 10,020,419.84$10,610,618.34$11,230,752.08$11,882,330.60$91,566,939.27$ Table 6. Cash Flow Statement of London investment5
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Table 7. Net Cash Flows of London investment6
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