- 12 Marks
AFM – Nov 2016 – L3 – Q3b – Discounted cash flow techniques
Calculate the Net Present Value (NPV) of a new product investment project considering real terms and inflation adjustments.
Question
A company plans to invest GH¢7 million in a new product. Net contribution over the next five years is expected to be GH¢4.2 million per annum in real terms. Marketing expenditure of GH¢1.4 million per annum will also be needed. Expenditure of GH¢1.3 million per annum will be required to replace existing assets, and additional investment in working capital, equivalent to 10% of contribution, will be needed at the start of each year. Working capital will be released at the end of the project. The following inflation forecasts are made for the next five years:
- Contribution: 8%
- Marketing: 3%
- Assets: 4%
- General prices: 4.70%
The real cost of capital is 6%. All cash flows are in real terms. Ignore tax.
Required:
Calculate the Net Present Value (NPV) of the project and appraise whether it is a worthwhile project.
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