ACCA · Question 31 · Investment Appraisal

Section C

OrbitLogix PLC is a commercial space-tech company evaluating a project to deploy a new network of low-earth orbit satellites. The project requires an immediate capital investment of $120 million for satellite manufacturing and launch vehicles.

The project is expected to generate the following real (current price) cash flows before tax:
Year 1: $30 million
Year 2: $45 million
Year 3: $55 million
Year 4: $40 million

At the end of Year 4, the satellites will be decommissioned. The decommissioning cost is estimated at $15 million in real terms.

Additional Information:

1. General inflation is expected to be 4% per year. All real cash flows (including decommissioning) will inflate at this general rate.
2. Tax-allowable depreciation (capital allowances) is available on the initial $120m investment at 25% per year on a reducing balance basis. A balancing allowance or charge will arise in Year 4 when the assets are scrapped for zero value.
3. Corporate tax is 20%, payable in the year the profit is generated.
4. The project requires an initial working capital investment of $10 million, which will increase by inflation each year. The total working capital will be fully recovered at the end of Year 4.
5. OrbitLogix has a nominal after-tax cost of capital of 12%.

Required:
(a) Calculate the nominal Net Present Value (NPV) of the satellite project and recommend whether it should be accepted. (15 marks)
(b) Discuss the concept of 'Real Options' in investment appraisal and identify two real options that OrbitLogix might possess in relation to this project. (5 marks)