Essays on Investment Appraisal of Elgar Pharmaceutical Ltds Proposed Investment Assignment

The paper "Investment Appraisal of Elgar Pharmaceutical Ltds Proposed Investment" is an outstanding example of a finance and accounting assignment. Net present value (NPV) is a superior investment appraisal tool. It seeks to measure by how much an investment increases the shareholder’ s wealth in absolute value and in today’ s terms (Dobson, 1997). It incorporates the all-important concept of the time value of money. This concept appreciates that a dollar received today is worth more than a dollar received tomorrow. This concept is incorporated in the net present value calculation by a process called discounting; this is done by multiplying future values by a discounting factor based on the discount rate (Dobson, 1997).   The discount rate represents the cost of capital.

In the case study of Elgar Pharmaceutical Ltd, the discount rate is 12%. This was arrived at based on the assumption that the tax rate is 20% per annum and that the bank’ s interest rate of 15% is the pre-tax cost of debt. Since interest on bank loans is tax allowable, then a post-tax cost of debt must be calculated.

This is done by multiplying the interest rate by, one minus the tax rate (interest rate * (1-interest rate) giving a rate of 12%. From the discount rate, a discount % is calculated, by adding one to the discount rate then raised to the power of time in years. In this case (1+12%) ^-1, this gives an annuity factor of 0.893 (rounded off). This figure can be obtained directly from the present value table in the column with12% and the row with year one. For the purpose of analyzing Elgar Pharmaceutical Ltd’ s investment, it is assumed that the post-tax cost of debt is equal to the company’ s weighted average cost of capital and thus it is an appropriate discount rate.

It is assumed that the whole of the initial capital outlay is to be incurred now/time zero. This eliminates the need to discount the \$ 400,000 cash outflow. It is normal for capital investments to attract capital allowances in terms of tax benefits but this has been ignored in this analysis.

References

Dobson, J. 1997. Finance ethics: the rationality of virtue. New York: Littlefield.

Helfert, E. 2001. Financial analysis: tools and techniques: a guide for managers.

Boston: McGraw-Hill.