1 * ( Examination level ) Mercia plc owns two acres of derelict land near to the centre of a major..

1* (Examination
level)
Mercia plc owns two acres of derelict land near to the centre of a major UK
city. The firm has received an invoice for 50,000 from consultants who were
given the task of analysis, investigation and design of some project proposals
for using the land. The consultants outline the two best proposals to a meeting
of the board of Mercia.

2* (Examination
level)
Mines International plc The Albanian government is auctioning the rights to
mine copper in the east of the country. Mines International plc (MI) is
considering the amount they would be prepared to pay as a lump sum

1* (Examination
level)
Mercia plc owns two acres of derelict land near to the centre of a major UK
city. The firm has received an invoice for 50,000 from consultants who were
given the task of analysis, investigation and design of some project proposals
for using the land. The consultants outline the two best proposals to a meeting
of the board of Mercia.

2* (Examination
level)
Mines International plc The Albanian government is auctioning the rights to
mine copper in the east of the country. Mines International plc (MI) is
considering the amount they would be prepared to pay as a lump sum for the
five-year licence. The auction is to take place very soon and the cash will
have to be paid immediately following the auction. In addition to the lump sum
the Albanian government will expect annual payments of 500,000 to cover
administration. If MI wins the licence, production would not start until one
year later because it will take a year to prepare the site and buy in
equipment. To begin production MI would have to commission the manufacture of
specialist engineering equipment costing 9.5m, half of which is payable
immediately, with the remainder due in one year. MI has already conducted a
survey of the site which showed a potential productive life of four years with
its new machine. The survey cost 300,000 and is payable immediately. The
accounts department have produced the following projected profit and loss
accounts.

The following additional information is available:

a Payments and receipts arise at the year ends unless
otherwise stated.

b The initial lump sum payment has been excluded from
the projected accounts as this is unknown at the outset.

c The customers of MI demand and receive a credit
period of three months.

d The suppliers of materials and consumables grant a
credit period of three months.

e The overheads contain an annual charge of 200,000
which represents an apportionment of head office costs. This is an expense
which would be incurred whether or not the project proceeds. The remainder of
the overheads relate directly to the project.

f The new equipment will have a resale value at the
end of the fifth year of 1.5m.

g During the whole of Year 3 a specialised item of
machinery will be needed, which is currently being used by another division of
MI. This division will therefore incur hire costs of 100,000 for the period
the machinery is on loan.

h The project will require additional cash reserves
of 1m to be held in Albania throughout the project for operational purposes.
These are recoverable at the end of the project.

i The Albanian government will make a one-off refund
of administration charges one and a half months after the end of the fifth
year of 200,000. The companys cost of capital is 12 per cent. Ignore
taxation, inflation and exchange rate movements and controls.

Required

a Calculate the maximum amount MI should bid in the
auction.

b What would be the Internal Rate of
Return on the project if MI did not have to pay for the licence?

c The board of directors have never been on a finance
course and do not understand any of the finance jargon. However, they have
asked you to persuade them that the appraisal method you have used in (a) above
can be relied on. Prepare a presentation for the board of directors explaining
the reasoning and justification for using your chosen project appraisal
technique and your treatment of specific items in the accounts. You will need to
explain concepts such as the time value of money, opportunity cost and sunk
cost in plain English.

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