Advanced Financial Functions

Assignment 1

Part 1

MDC plc is a UK-based company that operates countrywide mobile phone and wireless internet networks. In recent years, the company has become aware of its corporate image and reputation with highly visible news pieces alleging various pollutions to be caused by the industry. The company directors know that environmental issues become a concern to its customers, investors, and other key stakeholders. In the first stage of initiatives, the business is contemplating moving to renewable energy sources for its head office buildings. This involves substantial upfront investment in solar panels and a medium-size wind turbine to generate the required energy. As well as the environmental and spin-off reputational advantages, the directors trust that the investment will provide the business with significant financial returns. The renewable sources will significantly reduce utility costs; surplus energy can be sold to the national grid. The directors, however, expect that the technology would become obsolete and not worth maintaining after five years. The financial manager has been asked to assess this environmental capital investment. Cash flow forecasts are provided as follows.

Details

Year

Amount

Initial investment in solar
panels and wind turbine

£2,250,000

Projected cash savings on
utilities and selling to the grid:

£550,000

£850,000

£750,000

£450,000

£250,000

Additional scrap income
from the redundant equipment

£125,000

The financial manager has concluded that the appropriate discount factor for an investment with this type of risk is 8% (please round numbers to three decimal places during calculation).

Required:

a) Calculate and discuss the meaning of the payback period for the investment and compare to a company benchmark of 4 years. Evaluate the pros and cons of this technique. (10 marks)

b) Calculate the Net Present Value (NPV) of the project and evaluate the viability of this investment. Analyse the advantages of using NPV to value investments.

(15 marks)

c) The financial manager has decided that it would be prudent to assess a worstcase scenario and has concluded that under worst-case economic conditions the following would happen: the initial investment would decrease to £2,400,000 and there would be £0 scrap from the redundant equipment.

Calculate the NPV of this scenario. (10 marks)

d) A sensitivity chart has been drawn up for an alternative environmental project (involving installation of more energy efficient infrastructure). Three variables are analysed, including cash savings, discount factor, and initial investment. Assess the risk and returns of the investment and evaluate the pros and cons of sensitivity analysis. (15 marks)

Part 2

You are required to write one essay of between 800 to 1000 words to discuss the following two questions. Reference support is required for the essay.

a) What are the potential disadvantages of raising finance through a sale-andleaseback arrangement? (25 marks)

b) Why might a business that has a stock Exchange listing revert to being unlisted? (25 marks)