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Assignment AYRCo


Assignment AYRCo. is considering two separate projectsknown as ‘Aspire’ and ‘Wolf’ which are quite different but each of which has the potential to increase AYRCo.’s market share.To date $120,000 has been spent on market research into the increase in demand that can be expected for each project. The next stage is to conduct a financial appraisal to determine which project should be taken forward as AYRCo. can only afford to fund one project at this time.Project Aspire:This project will require the acquisition of plant and machinery costing $2,250,000 which is payable immediately. This machinery will have a scrap value of $375,000 at the end of the 5 years. There is also $140,000working capital to be used immediately. This amount has been taken from the company’s retained profitsand will be repaid at the end of the project. Cash inflowsare expected to be $650,000 in year 1 rising at a rate of 7.5% per annum for years 2 to 5inclusive. Variable costsin year 1 are expected to be$27,000 per annum and are expected to rise at 6.75% per annum. Capital allowances are available on the plant and machinery as follows:$Year 1Year 2Year 3Year 4Year 5600,000390,000345,000300,000240,000This project will expand the current product range and will appeal to existing and potential customers. Project Wolf:This project will require an immediate outlay of $2,250,000. This expenditure will not attract capital allowances. Annual cash inflowsof $955,000 areexpected to be constant for the life of the project.Material costs are expected to be $14,400 in the first year, rising at an annual inflation rate of 7.5% per annum. Other expenses are expected to be $18,000in year 1and these are expected to fall by 7.5% per annum over the life of the project.To undertake Project Wolf, factory space which is currently generating rental income will need to be used for the project. The rental income,which would nothave been expected to change over the five-yearperiod,is $75,000 per annum.This project will take the company in a new direction appealing to a different type of customer.Additional financial information:?Corporation tax is paid at a rate of 20% and tax is payable one year in arrears.?The weighted average cost of capital is 10% and, unless otherwise stated, cash flows occur at the end of the year to which they relate. ?A straight line method of depreciation at a rate of 20% is applied to allnon-currentassets.Theinitial investment of $2.250m, for whichever project is chosen, issignificantin terms of valuefor AYRCo. The board of directors isconsidering ways to finance the investment, and will choose between,increasing equity by issuingnew ordinary shares, ortaking on new debt in the form of a bank loanat a fixed rate of currently financed as follows:Capital Employed$millionEquity holder funds20Long term debt18Total38Required:Prepare a report to the Directors of AYRCo. which includes the following.1.A calculation of the Net Present Value (NPV), Internal Rate of Return (IRR) and Payback Period for projects Aspireand Wolf. Detailed calculations should be included as an appendix to the report. All cash flows should berounded to the nearest $. 30% 2.Analysis and evaluation of the investment project options as follows:i.A recommendation regarding which project (if any) to undertake;ii.Justifications for your recommendation including an evaluation of the investment appraisal techniques used in task 1 above.iii.Asummary of other factors that should be considered and information that may be needed prior to making a final decision.30%3.A discussion of the two sources of finance being considered by the board of AYRCo. Your report should include:i.A description of Equity and Debt.ii.An explanation of the costsof each sourceof finance.iii.An analysis of the effectthe selection of the source of finance may have on AYRCo.’s weighted average cost of capital.iv.An assessment of the impact of the selection of finance oncurrent and potential shareholders and lenders. 30%Marks are available for presentation of the report, which must not exceed 3,000 words. 10%

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