Answering Questions

  • Read each question carefully.
  • When you answer a question, your answer will automatically be saved.
  • You can revisit questions and change your answers at any time during the exam.
  • The only permitted characters for numerical answers are:
    • Numbers
    • One full stop as a decimal point if required
    • One minus symbol at the front of the figure if the answer is negative.

              For example: -10234.35

No other characters, including commas, are accepted.

Navigating between questions

  • Click Next Button to move to the next question.
  • Click Previous Button to move back to the previous question.
  • Click on a question number from the Exam Progress Details panel (see next page) to move directly to that question.
  • A message will be displayed when you click to move away from a question which has been partially attempted. You can choose to stay on the question and review your answer(s) or continue.
  • When reviewing your answer(s) for partially attempted questions ensure you read any message displayed in red text below the question in Section A or below the question
    part(s) in Section B
    .

VYXYN Co (Mar/Jun 17)

Vyxyn Co is evaluating a planned investment in a new product costing $20m, payable at the start of the first year of operation. The product will be produced for four years, at the end of which production will cease. The investment project will have a terminal value of zero. Financial information relating to the investment project is as follows:

Year

1

2

3

4

Sales volume (units/year)

440,000

550,000

720,000

400,000

 Selling price ($/unit)

26.50

28.50

30.00

26.00

Fixed cost ($/year)

1,100,000

1,121,000

1,155,000

1,200,000

These selling prices have not yet been adjusted for selling price inflation, which is expected to be 3.5% per year. The annual fixed costs are given above in nominal terms.

Variable cost per unit depends on whether competition is maintained between key suppliers of components. The purchasing department has made the following forecast:

Competition

Strong

Moderate

Weak

Probability

45%

35%

20%

Variable cost ($/unit)

10.80

12.00

14.70

The variable costs in this forecast are before taking account of variable cost inflation of 4.0% per year.

Vyxyn Co can claim tax-allowable depreciation on a 25% per year reducing balance basis on the full investment cost of $20m and pays corporation tax of 28% one year in arrears.

It is planned to finance the investment project with an issue of 8% loan notes, redeemable in ten years’ time. Vyxyn Co has a nominal after-tax weighted average cost of capital of 10%, a real after-tax weighted average cost of capital of 7% and a cost of equity of 11%.

Required:

A. Discuss the difference between risk and uncertainty in relation to investment appraisal.
B. Calculate the expected net present value of the investment project and comment on its financial acceptability and on the risk relating to variable cost.
C. Critically discuss how risk can be considered in the investment appraisal process.

Leave a Reply

Your email address will not be published. Required fields are marked *