CORPORATE FINANCE

COURSE ASSESSMENT 1
The final date for submission of this assessment without penalty is
24 June 2016
Assessment will be accepted for marking 14 days prior to the due date

Late Penalty System

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CORPORATE FINANCE
COURSE ASSESSMENT 1

The following assignment brings together many of the issues that are raised while studying
capital budgeting in Unit 1 of the study guide. This assignment will count for 20% of the total
marks.
Birmingham Airways plc is a large profitable firm currently considering a new project
involving an investment outlay of 1 million. The firm has decided to finance the project 50
percent by debt and 50 percent by equity.
The project will require working capital each year amounting to 10% of annual sales revenue;
this must be in place at the end of the previous year. At the end of the projects life
(year 4) the firm will recover any remaining investment in working capital. All revenues and
expenses occur at the end of each year.
The management accountant has drawn up the following forecast income statement for the
project (all figures in nominal terms):
Year
Sales revenue
Operating expenses
Interest on debt
Advertising costs
Salvage value

1
400,000
80,000
84,000
50,000

2
400,000
100,000
84,000
50,000

3
500,000
120,000
85,000
50,000

4
500,000
120,000
85,000
50,000
20,000

Net profit before tax

Net profit after tax (@ 35%)

64,000
41,600

84,000
54,600

5,000
3,250

5,000
3,250

Other information is as follows:

a) Capital allowance is allowable for tax purposes at 25% on a reducing balance
basis and any profit or loss on disposal attracts an immediate balancing charge.
b) The firm pays taxes with no lag. The corporation tax rate is 35%.
c) Debtholders require a 10% return.
d) Shareholders require a return of 19%.
e) The firm has already invested 100,000 in market research for the project to generate
the above income statement figures. This amount is omitted from the above figures.
Also omitted is the projects share of allocated R&D costs that the company spreads
across investment projects. The company has a fixed annual R&D budget of 3m and
will allocate 2% of this expenditure each year to the project as an overhead charge.

Please ensure you include your student number and the assignment reference (CF/Student
Number/May16/1) in all submitted assignments and that assignments are paginated. Failure to
do this may lead either to a grade not being assigned or being wrongly assigned

CORPORATE FINANCE
COURSE ASSESSMENT 1

f)

The advertising charge is the projects share of the firms corporate advertising bill;
however, the firm has no intention of changing the amount spent on corporate
advertising in response to its decision on this project.

g) No subsequent capital budgeting decisions rest on the accept/reject decision for this
project.
h) The project requires some special equipment in its first year. Another project has
been using the equipment, but this project is due to end. The company therefore
proposes to make no charge for using the equipment on the project. However, the
stores manager knows she can hire out this equipment for 20,000 if the company
has no use for it.
Required
a) Calculate the expected incremental after-tax cash flows for the project and hence find
the projects NPV. Should the firm accept or reject the project? Explain carefully
which figures you have included or excluded in your calculations. (60 marks)
b) What is the projects IRR and what is its payback period? (15 marks)
c) The IRR rule is redundant as an investment criterion because the net present value
(NPV) rule always dominates it. Discuss this statement giving examples where
possible. (25 marks)
The word limit for answers to questions (a), (b) and (c) is 2000 excluding tables and
references.
Information on the deadline for submitting this coursework and MBS rules on
assignments can be found on Blackboard.

Please ensure you include your student number and the assignment reference (CF/Student
Number/May16/1) in all submitted assignments and that assignments are paginated. Failure to
do this may lead either to a grade not being assigned or being wrongly assigned