solution

UHG ple runs a hotel chain. Assume that it is now UHG pic’s financial year end 31 March 2022. The
firm is considering a three-year project to build and operate rapid Covid-19 screening facilities next
to the hotels, with a view to improving sales for the hotels.
The company hired a consultant, at a cost of E100.000 (paid in full last month), to assess the likely
impact of these facilities on the hotels’ income. The findings by the consultant suggest that the most
likely impact would be an increase in sales of £200 million p.a. (70% probability). But the consultant
also suggests that, dependent on the pandemic situation, the increase in sales for each of the three
years could be as high as £300 million (10% probability) or as low as £50 million (20% probability).
UH pic generates a contribution of 40% on sales. This project will also lead to an incremental fixed
costs of £30 milion p.a, and an allocated head office fixed costs £10 million p.a.
The facilities will be built in a part of the company’s premises which is currently rented out to a travel
agent at an annual rent (taxable) of £2 million,
receivable In advance, The project also requires an
investment of £100 million in equipment on 31 March 2022. The equipment attracts a 20% (reducing
balance) capital allowance and will be disposed of for £20 milion after three years of use.
An investment in working capital of £500,000 will be required on 31 March 2022. This requirement
will remain constant each year throughout the 3-year life of the project. Working capital will be fully
recoverable on 31 March 2025.
Corporation tax is payable at the rate of 25% and tax payment occurs in the same year as the cash
flows to which it relates. An appropriate cost of capital to appraise the project is 12% p.a.
(a) Calculate the NPV of the Covid-19 screening facilities project as at 31 Mach 2022 and
advise the company whether it should proceed with the project.
(25 marks)
(b) Calculate the sensitivity of the NPV to changes in the expected extra contribution.