Reference no: EM133105659
Question - Company "A" is considering purchasing a mature forest in Finland at a cost of £3m. The company's lawyers have spent the last year examining the potential of the purchase and have incurred costs to date of £0.2m. The purchase price for logging equipment will be £1.5m in order to cut and process the timber and these assets can be sold for £0.5m in four years' time when the timber has been cut. The forest will then be sold ready for a new operator to start the next growing cycle. The proceeds from the sale are expected to be £0.8m which will be received at the end of year 4.
The Finance Director of the company has prepared the following projected figures for each year of operations:
|
Year
|
|
|
1
|
2
|
3
|
4
|
|
|
£m
|
£m
|
£m
|
£m
|
|
Sales
|
2.6
|
3.2
|
3.6
|
2.4
|
|
Wages and salaries
|
0.4
|
0.5
|
0.6
|
0.4
|
|
Power and processing costs
|
0.3
|
0.4
|
0.4
|
0.3
|
|
Materials and consumables
|
0.6
|
0.7
|
0.8
|
0.5
|
|
Construction of on-site building
|
0.2
|
|
|
|
|
Depreciation charges
|
0.25
|
0.25
|
0.25
|
0.25
|
The following additional information is available:
The project will require an investment of £0.4m of working capital from the beginning of the project until the end of the project.
At the end of year 4, the company will incur costs of £0.2m cleaning up the site.
Company "A" intends to allocate head office costs of £0.2m per year to the project.
These costs have not been included above and will be incurred whether or not the project is undertaken.
The company has a cost of capital of 10%.
Ignore taxation.
Required -
(a) Calculate the Net Present Value (NPV) and Internal Rate of Return (IRR) for the above project stating if the project should be undertaken or not giving reasons for your choice.
(b) Compare and contrast NPV and IRR as investment appraisal methods, include in your comparison which method you consider to be the best one to use for investment appraisal.