Question 1:

Green Energy Company has recently completed a $220,000, two-year study on its latest project, ‘Roof-top Solar”. It estimated that 28,000 units of its new Roof-top Solar units could be sold annually over the next 10 years at a price of $6,580 each. Subcontractors would install the unit at a cost of $4,700 per installation. Fixed costs of $11 million per annum will be incurred.

The initial outlay includes $52 million to build production facilities and $4.2 million in land. The $52 million facility will be depreciated using the prime cost method over the project’s life (fully depreciated at the end of the project). At the conclusion of the project the facilities (including the land) will be sold for an estimated value of $12.5 million. The land value is expected to increase by 1.5 per cent annually over the project period.

The firm is an ongoing profitable business and pays taxes at a 30% rate in the year of income. It uses a 10% discount rate on the new project.

Using the NPV approach, decide whether the project should be undertaken or not.


Question 2:

Build-Smart Construction Ltd wants to borrow $100,000 to finance a new $150,000 hydraulic machine to be used in a new construction project. The machine will pay for itself in one year. The firm is considering the following alternatives to buy the machine:

Option A: The firm’s bank offers to lend the $100,000 at a rate of 12% by arranging a bill for one year.

Option B: The machine dealer offers to finance the machine with a one-year loan of $100,000, and the loan would require payment of principal and interest totaling $115,500 at year-end.

(i)   Determine the face value of the bill.

(ii)  Which option should Build-Smart Construction Ltd. select?

(iii) What would be your answer if the bank charged a $3000 arrangement fee for the bill?

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