Financial management revision question and answer

CPA-Financial-Management-Section-3 Revision kit

Insect kill Ltd. is considering whether to establish a new subsidiary in Uganda. The cost of the fixed assets would be Sh.10,000,000 in total, with Sh.7,500,000 payable at once and the remainder payable after one year. A further investment of Sh.3,000,000 in working capital would be required immediately.

The management of Insect kill Ltd. expect all their investments to be financially justifiable within a four year planning horizon. The net disposal value of fixed assets after four years is expected to be zero.

The operation would incur fixed costs amounting to Sh.5,200,000 a year in the first year, including depreciation of Sh.2,000,000. These costs, excluding depreciation are expected to increase 5% each year because of inflation. The operation would involve the manufacture and sale of a standard unit, with a unit selling price of Sh.12 and variable cost of sh.6 in the first year and expected annual increase because of inflation of 4% and 7% respectively. Annual sales are expected to be 1,250,000 units.

The company‚Äüs cost of capital is 14%.

Required:
(a) Fixed costs for the four years.
(b) Total contribution for each of the four years.
(c) (i) Net Present Value of the project
(ii) Is the project viable?
ANSWER


(ii) The NPV is positive and so the project can be accepted as it is viable.

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