FNM191 Finance Theory and Practice:Part1:Investment Appraisal Max 1000Words
|Question # 45769||Business & Finance||1 year ago|
Part 1: Investment Appraisal Max 1000 words 35%
Presentation of your work:
Part 1 of the assessment, which requires you to undertake an investment appraisal, should be completed using an excel spreadsheet but full workings must be clearly shown. The excel spreadsheet must be submitted onto My Studies. A word document should be used to provide a discussion of any assumptions made regarding the investment appraisal, and the decision as to whether to accept or reject the project. The same word document must be used for your discursive answers to part b) and c). Your discussion should be presented professionally and fully referenced within the text where appropriate.
The Proposed Investment:
Leisure and Entertainment plc are considering a proposal to build and operate a new outdoor and indoor water park on a site in the south east of England for at least 7 years from the water park opening.
The plot of land on which the water park is to be built is already owned by the company but has not yet been developed. The original cost of the land to Leisure and Entertainment plc was £1.5 million but a local housing developer has recently offered the company £2 million to buy the land. The water park development will take one year to complete but the business terms of the building contractor stipulate that they require the building costs to be paid in full at the outset. The total build cost is estimated to be £4 million and the water park will be ready to open after one year.
Prior to the development of the water park proposal, the marketing department of Leisure and Entertainment plc conducted research into the potential demand in the south east for a new water park. This detailed market research cost in total £450,000 and in particular investigated how demand would respond to different prices. Two entry prices were identified and the probabilities associated with the number of visitors per month are identified below:
Prices of entry for opening year
Probability £20 £30
0.25 10,200 visitors 9,300 visitors
0.40 6,000 visitors 5,400 visitors
0.35 12,900 visitors 12,600 visitors
Following the opening year, it is anticipated that the price of entry would increase by 5% per annum during operational years without affecting visitor numbers. The annual costs of running and maintaining the water park are estimated to be £3 million in the opening year and these are expected to rise by 2% in each subsequent year of operation. The contribution generated from visitor spend on refreshments and souvenirs is estimated to average out at approximately £5 per visitor for each visit.
Corporate tax is payable one year in arrears at a rate of 30%. The accountant has also informed you that a writing down allowance on a 25% reducing balance basis, claimable from year 2 onwards, is applicable to an investment in machinery of £1 million. The investment in machinery has been included within the total build cost of £4 million. The machinery is expected to be used over the length of the proposed project and is expected to have a residual value of £100,000. The machinery is integral to the water park and cannot be sold separately.
At present Leisure and Entertainment plc intend to invest in the water park project for the long run, but after 7 operational years there is increasing uncertainty regarding cash flows. It has also been estimated that following 7 operational years the project could be sold on a going concern basis for £8 million. The accountant has also estimated that the company’s cost of capital appropriate for this project is 8%.
a) Evaluate which price Leisure and Entertainment plc should charge for entry to the water
park. You should present your evaluation on an excel spreadsheet. (5 marks)
b) Using the price you have recommended in part a) above, calculate the after-tax Net Present Value (NPV) of the water park proposal and advise Leisure and Entertainment plc as to whether they should accept or reject the project.
You should use a spread sheet to organise and present your calculations, and state clearly any assumptions that you have made in a word document, providing enough commentary to explain briefly the approach taken.
(20 marks, approximately 300 words)
c) Discuss the subjectivity of the NPV calculated and identify those areas of the
analysis that you consider to be particularly problematic in this regard.
(10 marks, approximately 700 words)
Assessment Criteria for Part 1
· An evaluation of which price Leisure and Entertainment plc should charge for entry to the water park: Is the approach used appropriate? Are the calculations correct? Have calculations been presented clearly on an excel spreadsheet?
· The after-tax NPV: Has the Net Present Value (NPV) method of investment appraisal been understood and applied appropriately? Has tax been incorporated accurately? Have the relevant cash flows been identified and included? Has all the information relevant to the NPV been identified and incorporated appropriately?
· Is the NPV clearly presented within an excel spreadsheet? Have the underpinning assumptions been explained; are these clear and realistic? Has the approach taken been clearly explained? Have sources used been referenced appropriately?
· Has the subjectivity of the NPV approach been discussed? Have areas within the analysis that could be considered particularly subjective been identified and discussed? Have sources used been referenced appropriately?
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