Question:

A large conglomerate with diverse business activities is currently considering whether it should commence Project X and has gathered the following data:

Project X Data

1. An initial investment of £54 million will be required on 1 January year 1. The project has a three year life with a nil residual value. Depreciation is calculated on a straight line basis.

2. The project is expected to generate annual revenue flows of £80m in year 1, £90m in year 2 and £100m in year 3. These values may vary by ±5%.

3. The incremental costs will be £50m in year 1, £60m in year 2 and £70m in year 3. These may vary by ±10%.

4. The most likely cost of capital is 10%.This may vary from 8% to 13% for the life of the project.

Additional information:

Assume that all cash flows other than the initial investment take place at the end of each year.

Use the written down value of the asset at the start of each year to represent the value of the asset for the year. Note: Ignore taxation

Required:

(a) Prepare two tables showing net profit, residual income and return on investment for each year of the project and also net present value (NPV) for:

(i) The BEST OUTCOME;

(ii) The WORST OUTCOME.

(b) Describe the distinctive features of Residual Income, Return on Investment and Net Present Value in measuring financial performance.