Question 1 (10 marks) Your company is doing well and has a profit of about $50,0

Question

Question 1 (10 marks)

Your company is doing well and has a profit of about $50,000. You want to make your profit work harder so you have looked at some investment opportunities available. They are

To insulate the current company offices at a cost of $18,000 which will provide a fuel savings of $1,600 per year over the next 10 years.

To pay the lump sum of $30,000 to the mortgage of $40,000 that has a loan term of 10 years at 6.5% interest per annum.

To invest $20,000 into a new business, which has been estimated to return the double amount in 6 years’ time.

To keep the profit $50,000 in an iSaver account earning a fixed interest of 4.5% per annum for 8 years. After 8 years, there will be no interest for this iSaver account.

Assumptions:

If only a part of the profit $50,000 is invested in a project, the remaining amount is still kept in the pocket (i.e. no investment).

The investment/cost occurs at the beginning of a year, and the investment benefits are obtained at the end of a year.

iSaver account calculates the compound interest.

Given the profit you have and assuming a discount rate of 4.8%, perform and document appropriate NPV calculations for 10 years for all possible investment options you identified. Graph the results to show the payback analysis of each investment option.

You must use Microsoft Excel or an equivalent spreadsheet program to perform and present your calculations.

[7 marks]

(b)   From your calculations in (a), which investment would you take up and why?

Use a Weighted Scoring Model to discuss the results and explain in detail why you have chosen one option over the others. It is not always just the figures that determine the final decision.

Explanation / Answer

Profit from the business - $50,000

option 1 - cost of current offices insulation - $18,000 (You pay $18,000 now and get a return of $1600 every year for 10 yrs).

So, the cost will be $18000, and benefit will be $1600 yearly for the next 10 years.

A W (Benefit) = $1600 x 10 = $16,000 in 10 years

A W (Cost) = $18,000

B/C = AW(Benefit)/AW(Cost) = $16000/$18000 = 0.88

Option 2 - To pay lumpsum to the mortagage - $30,000 (loan in hand is $40,000 and you decided to pay $30,000 of the loan now. In that case, you still need to pay $10,000 with 6.5% interest

@6.5% interest per year, you pay $650 every year. every additional year this adds up to the remaining amount.

Option 3 - Investing in the new business - $20,000

You pay $20,000 now and in year 6 you get $40,000. so the profit is $20,000. Your principal amount is locked for 6 years. Every year you approximately get a profit of $3334 on the amount you invested.

Option 5 - To save in isaver - $50,000 with an interest rate of 4.5% for 8 years. No investment after 8 years.

Benefit - adding 4.5% on the last year money. From year 2, the cost (what you put) is equal to your benefit from last year. Lets think that you re-invest your benefit every year. Say for example, in year 1, you invest X and you get Y. And in year 2 you put Y and you get Z and so on..

After 8 years, if you keep the money in the account without change(although the value changes because of its discount rate), then the discounted value/benefit is less than $50,000, since the interest rate (4.5%) is less than discount rate (4.8%)

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