All amounts are in $AUD. In order to satisfy the sharp increase in demand KGN is evaluating investing in a “Mega Warehouse” project in Australia. KGN has already identified two existing warehouses. In...

All amounts are in $AUD. In order to satisfy the sharp increase in demand KGN is evaluating
investing in a “Mega Warehouse” project in Australia. KGN has already identified two existing warehouses. In order to mitigate the risk and assess the fit for purpose of these facilities KGN asked “Axiom Ltd.” to conduct a technical due diligence. “Axiom Ltd.” is asking $100,000 as a fixed fee for its consulting services. Project A has an initial outlay of dollars $150 million and Project B has an initial outlay of $85 million.

Project A will generate additional revenues of 45 million starting at the end of year 1 until the end of year 10. It will also incur additional working capital expenses of $1million immediately, this working capital will be recovered at the end of the project. Project B will generate additional revenues of 25 million starting at the end of year 1 until the end of year 10. It will also incur additional working capital expenses of $2million immediately, this working capital will be recovered at the end of the project.

The operating costs of both projects will be 30% of the revenues from year 1-10. Both
investment will be depreciated on a straight-line basis over ten years to 0 book value. KGN has estimated that the “Mega Warehouses” can be sold at the end of year 10 respectively for $125 million (Project A) and $100 million (Project B). The tax rate is 30%. All cash flows are annual and are received at the end of the year. The weighted average cost of capital for both projects is 6%.

a) Calculate the FCFs to each project


b) What is the NPV for each project?


c) What is the Discounted Payback Period for each project?


d) What is the IRR for each project?


e) Assume that the risk of investing in these “Mega Warehouses” is higher than the overall risk of the company, what would happen to the discount rate and consequently NPV of the two projects? Why?


f) Suppose that KGN’ management payback rule is 7.5 years. Based on your analysis in b),


c) and d) which project should be chosen? Justify your answer with reference to theory.


What other factors might affect the final decision?