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- 20 Marks
Question
a) Sakyiama Poultry Farms is considering purchasing a new incubator that will improve its incubation efficiency to 90% as against the current 50%. The incubator, which is to be purchased immediately, will cost GH¢120,000. The incubator has a useful life of 4 years, after which it would be sold for scrap at GH¢10,000. The current contribution of GH¢3 per day-old chick will not change. The number of day-old chicks sold at 12,000 units per annum will increase by 80%. Fixed cost will be GH¢20,000 per annum. Sakyiama Farms has an after-tax cost of capital of 12.5% and pays tax in the year in which profit is made at a rate of 15% per annum. The farm is also entitled to capital allowance at 25% on a reducing balance.
i) Calculate the Net Present Value (NPV) and the viability of the investment. (7 marks)
ii) Calculate the Internal Rate of Return (IRR). (8 marks)
b) Two blue-chip companies – Abu Ltd and Ada Ltd are seeking to raise funds from venture capital to boost their production in order to satisfy demand for their solar-powered refrigeration and air-conditioning systems, which they developed through a joint venture. They have consulted you for advice.
Required:
Explain FIVE conditions that a venture capitalist will consider in accessing an application for funding. (5 marks)
Answer
a) Sakyiama Farms
i) Investment appraisal
| Years | 0 | 1 | 2 | 3 | 4 |
|---|---|---|---|---|---|
| Cost | 120,000.00 | 90,000.00 | 67,500.00 | 50,625.00 | 37,968.75 |
| Capital Allowance | 30,000.00 | 22,500.00 | 16,875.00 | 12,656.25 | |
| Tax Gain | 4,500.00 | 3,375.00 | 2,531.25 | 1,898.44 | |
| Additional Gain (37,968.75-10,000) x 15% | 398.44 | ||||
| Contribution (64,800 units/year) | 64,800.00 | 64,800.00 | 64,800.00 | 64,800.00 | |
| Fixed Cost | (20,000.00) | (20,000.00) | (20,000.00) | (20,000.00) | |
| Cash Flow Before Tax | 44,800.00 | 44,800.00 | 44,800.00 | 44,800.00 | |
| Tax (15%) | (6,720.00) | (6,720.00) | (6,720.00) | (6,720.00) | |
| Tax Gain | 4,500.00 | 3,375.00 | 2,531.25 | 1,898.44 | |
| Additional Gain | 398.44 | ||||
| Cost of Incubator (120,000.00) | |||||
| Scrap Value | 10,000.00 | ||||
| Net Cash Flow | (120,000.00) | 42,580.00 | 41,455.00 | 40,611.25 | 50,376.88 |
| Discount Factor (12.5%) | 1.000 | 0.889 | 0.790 | 0.702 | 0.624 |
| Present Value | (120,000.00) | 37,848.89 | 32,754.57 | 28,522.58 | 31,450.04 |
| Net Present Value | 10,576.07 |
Total for this part: 7 marks
ii) IRR Calculation
| Years | 0 | 1 | 2 | 3 | 4 |
|---|---|---|---|---|---|
| Net Cash Flow | (120,000.00) | 42,580.00 | 41,455.00 | 40,611.25 | 50,376.88 |
| Discount Factor (17%) | 1.000 | 0.855 | 0.731 | 0.624 | 0.534 |
| Present Value | (120,000.00) | 36,393.16 | 30,283.44 | 25,356.47 | 26,883.62 |
| Net Present Value | (1,083.31) |
The IRR calculated using interpolation is approximately 15.67%.
Total for this part: 8 marks
b) Venture Capitalist Considerations
Venture capitalists will evaluate a funding application based on:
- Nature of the Company’s Products: The products should generate adequate and sustainable sales and profits.
- Expertise in Production: Technical efficiency and value-driven competencies must be demonstrated.
- Expertise in Management: Management should show commitment, skills, and experience in promoting the company’s objectives.
- Market and Competition: The company should have a competitive strategy to maintain and expand its market share.
- Future Profits: The company’s ability to generate realistic and sustainable future profits should be evident in its business plan.
- Board Membership: The company should have a board of directors that effectively represents stakeholders’ interests.
- Risk Borne by Existing Shareholders: The company’s owners should bear a significant portion of the risk.
- Topic: Cost of capital, Introduction to Investment Appraisal
- Series: NOV 2016
- Uploader: Joseph