Reference no: EM132620254

Perfection Ltd, an international kitchen appliance manufacturer, is considering entering the South African market due to demand for its appliances which are being used regularly on cooking shows televised in South Africa. They have identified either Durban or Port Elizabeth as the site for their manufacturing facility. The company's target payback period for the Durban facility has been set at 4 ½ years. Perfection Ltd has a cost of capital of 12%.

Independent research has projected the following cash flows for the next eight years for the Durban facility whilst the Port Elizabeth facility will be a smaller operation and two years of expected cash flows have been compiled. Perfection Ltd expects to invest a further R 1 500 000 in year five for Durban in order to upgrade the machinery.

This hasn't been included in year 5 cash flows yet.

Initial investment: DURBAN = R25 500 000 and PORT ELIZABETH= R9 500 000

Cash Flows:

DURBAN PORT ELIZABETH

Year 1: R4 200 000 R5 400 000
Year 2: R5 150 000 R6 750 000
Year 3 : R5 300 000
Year 4 : R5 800 000
Year 5 : R6 000 000
Year 6 : R6 350 000
Year 7 : R5 900 000
Year 8 : R4 800 000

REQUIRED:

1. Calculate the payback period for the Durban facility and advise whether Perfection Ltd should select Durban based on this appraisal method by providing a reason for your answer. (Round to two decimal places)

2. Calculate the Net Present Value (NPV) for Durban using a financial calculator and advise whether Perfection Ltd should select Durban based on this appraisal method by providing a reason for your answer. Clearly show your inputs into the calculator. Round to the nearest Rand.

3. Using a re-investment approach calculate the Net Present Value (NPV) for the Port Elizabeth manufacturing facility in order to compare the two projects. Based on your answer and with reference to you answer in question 2, advice which project should be accepted. Show all workings. Round to the nearest Rand.

4. Perfection Ltd also wants to expand into two other countries. The project in country A will require an initial investment of R4 000 000 and country B R5 000 000. The project in country A will have a life span of 7 years and a required rate of return of 18%. The project in country B will have a life span of 5 years and a required rate of return of 15%. It is expected that equal annual operating cash flows will be received and that there will be no terminal value. Calculate the break-even cash flow of each project and identify the project with the lowest break-even cash flow.