【FNCE2000】Introduction to Finance Principles

IMPORTANT INSTRUCTIONS:

• Show all working to demonstrate you have understood how to solve each problem.
• If you use a financial calculator, state the sequence of steps to solve the problem.
• Please present your answers in at least 4 non-zero decimal places.  i.e., 0.00001234 or 0.1234.
• Students are to submit their assignments onto Blackboard.  The assignment must be typed (Word, Excel or PDF).
• Answer must be legible.  If the marker cannot follow or read your answers, marks cannot be rewarded.
• Answer all sections.  

Your assignment should meet the following requirements

• A copy of the assignment has been retained by me
• Declaration below is complete

Declaration

Except where I have indicated, the work I am submitting in this assignment is my own work and has not been submitted for assessment in another Unit or course.  I warrant that any computer files submitted as part of this assignment have been checked for viruses and reported clean.

________________________________________

(Signature of student)

All forms of plagiarism, cheating and unauthorised collusion are regarded seriously by the University and could result in penalties including failure in the course and possible exclusion from the University.  If you are in doubt, please contact your lecturer, Unit Controller, or your Course Coordinator.

Part 1 (25 marks) – Capital Budgeting

As a senior analyst for Lawton Enterprise, you have been asked to evaluate a new computer hardware project with the following characteristics:

• Acquiring a computer hardware for a cost of $2,500,000.
• The computer hardware has an expected six-year life.
• The initial investment in net working capital (in Year 0) is $500,000. The investment in working capital is to be completely recovered by the end of the project’s life (in Year 6).
• The computer hardware can be depreciated on a straight-line (prime cost) basis and there is no expected salvage value after six years.
• The produced software is expected to generate sales of $1,250,000 in Year 1.  They grow at a 25% annual rate for the next two years, and then grow at a 10% annual rate for remaining years.
• Fixed operating expenses are $100,000 for Years 1-3 and $110,000 for Years 4-6.
• Variable operating expenses are 20% of sales in Years 1-2 and 25% of sales in Years 3-6.
• Lawton does not have any available space where the project can be located for six years and you anticipate to rent the required office space it would cost $65,000 per year for the life of the project. You expect that the project will need to hire three new software specialists at $50,000 (each specialist) per year (start in Year 1) for the full six years to work on the software.
• The project will use a van currently owned by Lawton.  Although the van is not currently being used by Lawton, it can be rented out for $20,000 per year for six years. The book value of the van is $20,000. The van is being depreciated straight-line (with six years remaining for depreciation) and is expected to be worthless after the sixth year.
• Lawton’s marginal tax rate is 35%, and the discount rate is 11.5%.  

Based on the information presented above, answer the following questions.

1. (12 marks)

Calculate the incremental free cash flow during the project’s life (starting from Year 0 to Year 6).  Show workings.  

1. (13 marks)

Calculate the NPV, payback period and IRR of the project. Should the project be accepted? Show workings and explain your answer(s).