3BM070: Evaluate capital investment projects using a range of techniques including the assessment of risk: Strategic Corporate Finance Assignment, YBS, Singapore

Learning Outcomes:

1. Evaluate capital investment projects using a range of techniques including the assessment of risk.

Introduction

You work at the headquarters of the Yorkshire Wind Farm Company and are responsible for the evaluation of capital projects. The business is currently trying to decide between 2 proposed wind farms. One is small and onshore and the other is larger and offshore. Each is expected to have a life of 15 years.

Revenue

The revenue is made up of the amount of electricity generated and the price per Megawatt hour (MGH). Both wind farms are expected to generate 130 MWH per year for the duration of the project.

However, the revenue per MWH is expected to change in line with government incentives The revenue is expected to be as follows:

The changes reflect the expectation that generation costs will reduce in the future and that offshore wind power is less environmentally intrusive but requires more incentives.

It is expected that a full year’s revenue will be available from year 1 onwards.

Capital costs

The following table shows the expected capital costs of each wind farm.

Forecast Income statements

The accountant has prepared the following forecast Income statements over the life of the projects. They have been prepared on the accruals basis.

Further information

The following information is also available:

1. Payments and receipts arise at the year ends unless otherwise stated.
2. The project is expected to have an anticipated life of 15 years.
3. All costs and revenues are expressed at today’s prices (year zero) with no allowance for inflation.
4. This equipment will have a zero resale value at the end of year 15.
5. The government grant will be received in year 1. However it has been spread over the life of the project in the profit and loss accounts.
6. The preparatory costs have already been incurred.
7. The annual management fees for both projects include afee of £10,000 which is an apportionment of head office overheads.
8. The refurbishments in year 5 require the use of specialised equipment that will be borrowed from another division of the Company. This will cost the other division additional hire costs of £200,000 per project and is not reflected in the profit and loss accounts.
9. An initial cash reserve is needed for each project. It will bepaid back at the end of year 15.
   • Onshore £1,000K
   • Offshore £3,000K
10. Ignore corporation tax.
11. The Yorkshire Wind Farm Company has a cost of capital (discount rate) of 10%.
12. They have a current return on capital employed(ROCE) of 12% and this is expected to be met by new projects. à ARR
13. They expect projects to have a payback period of no more than 5 years

Required:

Task 1 Calculations using the spreadsheet

1. Enter relevant cash flows into the data input cash inflows as positive numbers and cash outflows as negative numbers.
2. Perform a sensitivity analysis on both projects. Use the sensitivity worksheet to adjust each variable and enter your results on the sensitivity

Task 2 Written

1. Explain your reasons for any adjustments to the accountant’s figures and as a result of points a) to m) above. You should refer to any relevant accounting concepts.

2. State, with reasons which project you would accept. You should use the figures in the calculations worksheet for Net present value (NPV), Internal Rate of Return (IRR), accounting rate of return (ARR), and Payback Period

3. Critically evaluate the results of your sensitivity analysis.

4. Discuss critically the contribution expected values could make to the evaluation of the two projects. (You are not expected to do any calculations for this task)