(1) An investor is considering opening a factory in local UK village. This will incur some initial expenses and monthly operation costs. This factor will generate revenue straight away. Let us call this Strategy A. The best estimate of the cash flow is summarised below:

Table 1.  Summary of Strategy A.

The investment horizon is 10 years, after which point the factor will shut down. For simplicity, assume that no capital can be regained by selling o↵ assets at the end of this period. Moreover, assume that the e↵ective interest rate is 3 % per annum throughout.

(a) Calculate the Net Present Value (NPV) of this investment.

(b) From the second year onwards, operational cost will increase by 2% at the start of each year, in line with inflation. Calculate the revised NPV of this project.

(c) Write down the equation of value of this investment with the revised cash flow.

(d) Using a suitable numerical method, calculate the rate of return on investment. For the rest of this paper - assume that an annual inflation rate of 2% is in place.

(2) The investor now has the option to pursue an alternative strategy, which involves more aggressive investment in the factory facility. The more expensive equipments are expected to boost productivity and thus overall revenue. There is one catch: the additional time taken to implement this strategy means the factory will not generate any revenue for the first two years. Let us call this strategy B.

Table 2.  Summary of Strategy B.

(a) Calculate the Rate of Return of this new strategy.

(b) Plot the NPV curves for these strategies for di↵erent values of e↵ective interest rate.

(c) If the curves intersect, briefly explain why.