Question

QUESTION 1 April 2018 #2 Daveka Limited, a venture capital company is seeking to purchase a company in manufacturing sector. If purchased, it is Daveka's intention to expand this pany using high quality equipment including top of the line labelling machines, so that it could export more than 50% of its products throughout the region. This expansion proposal is supported by marketing studies will reveal that there is a demand for the products in the regional market of this targeted company. At the end of four years, it is the shareholders intention to sell off the company and retire in a homestead in Guyana. Riad Goberdhan, the New Business Director, reluctantly prepared the following projections based on sales (including the exports) as indicated by the independent marketing studies for this light manufacturing company: 2018 (8000) 105,000 2019 (8000) 115,500 2020 (8000) 127,050 2021 (5000) 139.755 Sales Direct costs Other Expenses Depreciation Total expenses Prefit before tax Corporate tax @ 30% Profit after tax 57,750 20,900 23,750 102,400 63,525 26,130 17,813 107,468 8,033 (2,811) 5,221 69,878 30,280 13,359 113,517 13,533 (4.737) 8,797 76,865 32,900 10.020 119,785 19,970 (6.990) 12,981 (910 1.690 Riad Goberdhan's presentation to the Board was lacklustre and concluded by not recommending that the target company be acquired and expanded. Based on his projections, he reasoned that the cumulative after-tax profit over the four years period amounts to only $28 million, and it is estimated that the company will only be able to be sold for $60 million after four years. That, he exclaimed, is well under the $95 million that Daveka will have to invest in this project and, as a result investment in proposed project will destroy shareholders' value.

Answer 1

a) Calculation of NPV of the project Present Value of Cash Outflow Particulars Amount In millions) Cost of company New Equipment Present Value of Cash Outflow Yr Present Value of Cash Inflow Net profit Cash Inflow Depreciation after tax After Tax 3/4=2+3 2018 1690 23750 25440 2019 5221 17813 23034 2020 8797 13359 22156 2021 12981 10020 23001 2021 60000 60000 (Figures in $000) Opportunity Total Cash Inflow Discounting PV cost After Tax Factor @ 14% 5 6=4-5 7867 6000 19440 0.8772 17052.63 6000 17034 0.7695 13107.11 6000 16156 0.6750 10904.84 6000 17001 0.5921 10065.96 6000 54000 0.5921 31972.33 83102.87 PVCI = Million $ 83.103 NPV = PVCI - PVCO NPV = 83.103-95 NPV = - Million$11.9

b) Calculation of payback period Total Cash Cumulative Yr Inflow Cash Inflow After Tax After Tax 2018 19440 19440 2019 17034 36474 2020 | 16156 52630 2021 17001 69631 2021 54000 123631 Since the Cash outflow is getting recovered in 4th year, Payback period is 4 Years