ExpertACCA · Question 31 · Investment Appraisal
Section C
NeuroMed PLC - Investment Appraisal
NeuroMed PLC is a biotechnology company evaluating the construction of a new manufacturing facility for a recently approved drug. The project requires an immediate initial investment of $5,000,000 in plant and machinery.
The project has an expected life of 4 years, after which the plant and machinery will be sold for an estimated scrap value of $800,000 (in nominal terms).
Sales and Cost Projections (in current Year 0 terms):
- Year 1 Sales Volume: 100,000 units
- Year 2 Sales Volume: 150,000 units
- Year 3 Sales Volume: 150,000 units
- Year 4 Sales Volume: 80,000 units
- Selling price per unit: $40
- Variable cost per unit: $15
- Fixed operating costs: $500,000 per annum
Inflation Expectations:
- Selling price inflation: 4% per annum
- Variable cost inflation: 5% per annum
- Fixed operating costs inflation: 3% per annum
Taxation and Capital Allowances:
- NeuroMed pays corporate tax at a rate of 25%, payable in the same year the profit is generated.
- Tax-allowable depreciation (capital allowances) is available on the plant and machinery at 25% per annum on a reducing balance basis. A balancing charge or allowance will arise in Year 4 upon disposal.
Cost of Capital:
- NeuroMed's nominal after-tax weighted average cost of capital (WACC) is 12%.
Required:
(a) Calculate the Net Present Value (NPV) of the proposed manufacturing facility. (14 marks)
(b) Calculate the Internal Rate of Return (IRR) of the project. (You may use discount rates of 10% and 20% for your interpolation). (4 marks)
(c) Briefly discuss how the incorporation of 'Real Options' might alter the investment decision for NeuroMed. (2 marks)
Section C
NeuroMed PLC - Investment Appraisal
NeuroMed PLC is a biotechnology company evaluating the construction of a new manufacturing facility for a recently approved drug. The project requires an immediate initial investment of $5,000,000 in plant and machinery.
The project has an expected life of 4 years, after which the plant and machinery will be sold for an estimated scrap value of $800,000 (in nominal terms).
Sales and Cost Projections (in current Year 0 terms):
- Year 1 Sales Volume: 100,000 units
- Year 2 Sales Volume: 150,000 units
- Year 3 Sales Volume: 150,000 units
- Year 4 Sales Volume: 80,000 units
- Selling price per unit: $40
- Variable cost per unit: $15
- Fixed operating costs: $500,000 per annum
Inflation Expectations:
- Selling price inflation: 4% per annum
- Variable cost inflation: 5% per annum
- Fixed operating costs inflation: 3% per annum
Taxation and Capital Allowances:
- NeuroMed pays corporate tax at a rate of 25%, payable in the same year the profit is generated.
- Tax-allowable depreciation (capital allowances) is available on the plant and machinery at 25% per annum on a reducing balance basis. A balancing charge or allowance will arise in Year 4 upon disposal.
Cost of Capital:
- NeuroMed's nominal after-tax weighted average cost of capital (WACC) is 12%.
Required:
(a) Calculate the Net Present Value (NPV) of the proposed manufacturing facility. (14 marks)
(b) Calculate the Internal Rate of Return (IRR) of the project. (You may use discount rates of 10% and 20% for your interpolation). (4 marks)
(c) Briefly discuss how the incorporation of 'Real Options' might alter the investment decision for NeuroMed. (2 marks)
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