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ABC company is considering investment in a new system that will significantly reduce hazardous emisisons and waste.
The estimates for the proposed investment are as follows:
Initial Investment $50 million
Useful Life 5years
Residual Value $10 million
Annual income
from sales of recylced waste $10 millionAnnual savings in waste disposal costs $7million
Annual fixed maintenance costs $1.5 million
Other annual fixed operating costs (including depreciation) $12 million
The company’s policy on environmental management has emerged as a result of environmental failures that have occured past few years.
These failures have led to government fines of $15 million per annum, which the company are due to continue paying for the next 10years.The cost of capital is 12%
a) Calculate NPV and IRR
b) Calculate paybackMy question:
1. I would like to ask the annual fixed maintenance costs and other annual fixed operating costs are there need to be included in calculating NPV?
2. Does fixed costs relevant to LONG TERM DECISION MAKING?
3. Can I know what will be the cash inflow and outflow?Tq sir
You must have an answer in the same book in which you found the question, and so in future you should ask about whatever it is in the answer that you are not clear about – then I will explain.
1. You include all cash flows that change as a result of doing the investment – whether they are fixed or not is of no relevance. Obviously you do not include depreciation because it is not a cash flow.
2. Of course they are – why should they not be?
3. Again you must already have an answer (unless you have been set this as a test question, in which case we do not do your assignments for you 🙂 )Have you actually watched my free lectures on investment appraisal? The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
I gt watched your free lectures and study the lectures note.
The answer provided is the annual fixed maintenance fees and other fixed annual operating costs are not included in the calculation of NPV so I feel weird about it.
I also found out that the payback period are not within the system life span.
Is that possible to have this kind of scenario?
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