Part A BLC Ltd. is a medium-sized UK manufacturing company based in Liverpool. T
ID: 2749025 • Letter: P
Question
Part A
BLC Ltd. is a medium-sized UK manufacturing company based in Liverpool. The company is seeking to expand its operations with the establishment of an office block to house the marketing and human resources staff in Manchester. The company has narrowed the choice to two alternatives with the following net cash flow information being available:
Year
Property 1
Property 2
£000s
£000s
0
(2,500)
(2,750)
1
1,000
900
2
500
700
3
600
800
4
1,000
600
5
900
700
Items to keep in mind:
· The company’s current cost of capital is 10%.
· ignore taxation.
Question 1 : calculate net present value, internal rate of return and payback, and advise the company which option they should take.
Question two: critically evaluate the other qualitative factors that might be taken into account in this decision.
Part B
BLC Ltd. has revenue of £500 million and sells all of its goods on credit to a variety of different wholesale customers. At the moment the company offers a standard credit period of 30 days. However, 70% of its customers (by revenue) take an average of 70 days to pay, while the other 30% of customers (by revenue) pay within 30 days. The company is considering offering a 2% discount for payment within 30 days and estimates that 80% of customers (by revenue) will take up this offer (including those that already pay within 30 days).
The Managing Director has asked the credit controller if the cost of this new policy would be worth offering. The company has a £80 million overdraft facility that it regularly uses to the full limit due to the lateness of payment and the cost of this overdraft facility is 15% per annum.
The credit controller also estimates that bad debt level of 2% of revenue would be halved to 1% of revenue as a result of this new policy.
1. Calculate the approximate equivalent annual percentage cost of a discount of 2%, which reduces the time taken by credit customers to pay from 70 days to 30 days.
2. Calculate the value of trade receivables under the existing scheme and the proposed scheme at the year-end.
3. Evaluate the benefits and costs of the scheme.
4. explain with reasons whether the company should go ahead and offer the discount. You should also consider other factors in this decision. (Hint: You need to work out the cost of the discount compared to the interest on the overdraft saved and bad debt reduction.)
Year
Property 1
Property 2
£000s
£000s
0
(2,500)
(2,750)
1
1,000
900
2
500
700
3
600
800
4
1,000
600
5
900
700
Explanation / Answer
Part A:
Question 1:
The required NPV table is as below:
Year
P1 NCF
P2 NCF
10% factors
NPV of P1
NPV of P2
0
(2,500)
(2,750)
1
(2,500)
(2,750)
1
1,000
900
0.9091
909.1
818.19
2
500
700
0.8264
413.2
578.48
3
600
800
0.7513
450.78
601.04
4
1,000
600
0.6830
683
409.80
5
900
700
0.6209
558.81
434.63
514.89
92.14
The required IRR table is as below:
NPV of P1 at 10% rate
20% factors
NPV of P1 at 20% rate
NPV of P2 at 10% rate
20% factors
NPV of P2 at 20% rate
(2,500)
1
(2,500)
(2,750)
1
(2,750)
909.1
0.8333
833.30
818.19
0.8333
749.97
413.2
0.6944
347.20
578.48
0.6944
486.08
450.78
0.5787
347.22
601.04
0.5787
462.96
683
0.4823
482.30
409.80
0.4823
289.38
558.81
0.4019
361.71
434.63
0.4019
281.33
514.89
(128.27)
92.14
(480.28)
IRR of P1 = 10% + [(NPV at 10%)/ {(NPV at 10%) – (NPV at 20%)}] × 10
= 10% + [514.89 / (514.89 + 128.27)] × 10
= 10% + 8%
= 18%
IRR of P2 = 10% + [(NPV at 10%)/ {(NPV at 10%) – (NPV at 20%)}] × 10
= 10% + [92.14 / (92.14 + 480.28)] × 10
= 10% + 1.61
= 11.61%
Payback period of P1:
The NCF of 1 to 3rd year is 2,100. In order to recover 2,500, the balance amount of 400 should be taken from the 4th year amount, 1,000.
Therefore, payback P1 = 3 + (400 / 1,000) = 3 + 0.4 = 3.4 year
The NCF of 1 to 3rd year is 2,400. In order to recover 2,750, the balance amount of 350 should be taken from the 4th year amount, 600.
Therefore, payback P1 = 3 + (350 / 600) = 3 + 0.58 = 3.58 year
Advise: The company should take P1 option, since this option has higher NPV, higher IRR, and shorter payback period compare to P2 option.
Question 2:
Qualitative factors are as below:
1. Quality of output: The alternative giving the better quality of output should be considered.
2. Minimum scrap: The alternative uses the factors of production (land, labor, capital, organization) in better way and giving the minimum outcome of scrap should be considered.
Year
P1 NCF
P2 NCF
10% factors
NPV of P1
NPV of P2
0
(2,500)
(2,750)
1
(2,500)
(2,750)
1
1,000
900
0.9091
909.1
818.19
2
500
700
0.8264
413.2
578.48
3
600
800
0.7513
450.78
601.04
4
1,000
600
0.6830
683
409.80
5
900
700
0.6209
558.81
434.63
514.89
92.14
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