A company plans to invest GH¢7million in a new product. Net contribution over the next five years is expected to be GH¢4.2million per annum in real terms. Marketing expenditure of GH¢1.4m per annum will also be needed. Expenditure of GH¢1.3m per annum will be required to replace existing assets which will now be used on the project but are getting to the end of their useful lives. This expenditure will be incurred at the beginning of each year. Additional investment in working capital equivalent to 10% of contribution will need to be in place at the start of each year. Working capital will be released at the end of the project.
The following forecasts are made of the rates of inflation each year for the next five years:
Contribution 8%
Marketing 3%
Assets 4%
General prices 4.70%
The real cost of capital of the company is 6%. All cash flows are in real terms. Ignore tax.
Required:
Calculate the Net Present Value (NPV) of the project and appraise whether it is a worthwhile project. (12 marks)
View Solution
The Net present value = -8754 + 1,537+1,599+1,650+1,695+3,063 = 790,000
The positive NPV shows the project is worthwhile.
W2, cost of capital
(1+i)=(1+r)(1+h)=(1+0.06)(1+0.047)=1.11, hence 11%