Question

Limitless Ltd. is planning to buy a new warehouse to store its production output. The investment would require £500,000 to be paid upfront. Thanks to the new warehouse, the company expects to increase its profits by £120,000 annually for the next five years, and then €60,000 for the following five years. A. Calculate the Net Present Value (NPV) of this investment opportunity if the cost of eapital is 12%. B. Should Limitless Ltd. go ahead with the purchase of the new warehouse? Explain your reasoning.

Answer 1

The NPV of Limitless Ltd.'s potential warehouse investment requires a calculation of the discounted value of future profits at a 12% cost of capital. The cumulative discounted profits over the ten-year period are summed and compared against the initial investment. A positive NPV suggests a profitable investment, while a negative NPV would advise against proceeding.

Step-by-step explanation:

To calculate the Net Present Value (NPV) for Limitless Ltd.'s new warehouse investment, we need to discount the expected future profits back to their present value at the given cost of capital, which is 12%. Considering that the investment results in £120,000 of increased annual profits for the first five years and then £60,000 for the following five years, we perform a separate present value calculation for each time period.

Once we have the present values, we sum them up and subtract the initial investment of £500,000 to get the NPV. If the NPV is positive, it generally indicates that the investment should be considered as it's expected to generate more value than the cost of investment when considering the cost of capital. Conversely, a negative NPV suggests that the expected profits do not outweigh the upfront cost and the investment may not be worthwhile.