3.(a) Use a discounting method to assess the profitability of a proposed 40 000
ID: 2807535 • Letter: 3
Question
3.(a) Use a discounting method to assess the profitability of a proposed 40 000 t y acetic acid plant using the data below. The plant is based on conventional technology and the market is well-established. (13 marks) DATA Capital cost Operating cost 250/tonne product Income Working capital 3 months operating costs Plant life 30 million, built in one year 450/tonne product 5 years (b) Explain the meaning of the following terms. Amortisation. (4 marks) (ii) Economy of scale. (5 marks) (ii) Return on investment. (5 marks)Explanation / Answer
Amortization refers to the process of allocating the cost of an intangible asset over a period of time. It is also called to the repayment of loan principal over time.Amortization is the write off of an asset over its expected period of use, which shifts the asset from the balance sheet to the income statement.
2-Economies of scale arise when unit costs fall as output rises.The reduction in long-run average and marginal costs arising from an increase in size of an operating unit (a factory or plant, for example). Economics of scale can be internal to an organization (cost reduction due to technological and management factors) or external (cost reduction due to the effect of technology in an industry
3- Return on investment (ROI) is a ratio used to calculate the benefit an investor will receive in relation to its investment cost, most commonly measured as net income divided by the original cost of the investment. The higher the ratio, the greater the benefit earned.
cost of machine
30000000
investment in working capital
250*40000*3/12
2500000
total initial investment
32500000
annual sales
40000*450
18000000
annual cost
40000*250
10000000
annual operating profit
8000000
we have taken 10% as discount rate to find the present value of cash flow
Year
cash flow
present value of cash flow = cash flow/(1+r)^n r= 10%
0
-32500000
-32500000
1
8000000
7272727.3
2
8000000
6611570.2
3
8000000
6010518.4
4
8000000
5464107.6
5
10500000
6519673.9
Net present value
sum of present value of cash flow
-621402.5
Project NPV is negative at 10% discount rate so it should not be accepted
cost of machine
30000000
investment in working capital
250*40000*3/12
2500000
total initial investment
32500000
annual sales
40000*450
18000000
annual cost
40000*250
10000000
annual operating profit
8000000
we have taken 10% as discount rate to find the present value of cash flow
Year
cash flow
present value of cash flow = cash flow/(1+r)^n r= 10%
0
-32500000
-32500000
1
8000000
7272727.3
2
8000000
6611570.2
3
8000000
6010518.4
4
8000000
5464107.6
5
10500000
6519673.9
Net present value
sum of present value of cash flow
-621402.5
Project NPV is negative at 10% discount rate so it should not be accepted
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