Question

Darn Plc is a large company listed on a major stock exchange. In recent years, the board of Darn has been criticised for weak corporate governance and two of the

company's non-executive directors have just resigned. A recent story in the financial media has criticised the performance of Darn Plc and claims that the company is failing to satisfy the objectives of its shareholders. Darn Plc is considering the installation of a new computer system using specially written software to streamline the business's warehousing operations. The initial outlay on the project will be substantial. A feasibility study has already cost £20,000.The finance director estimates that payments to the software house will be £100,000immediately, with a further £75,000 in a year's time. New equipment and installation and testing costs will amount to £148,000 during the first year (it should be assumed for appraisal purposes that these costs arise in year 1). The plan is that the new system should go live in one year's time. After that point the business should start to reap considerable benefits from what will be, essentially, a paperless ordering and shipment tracking system. Darn Plc plans to reduce their staffing levels considerably during the first two years during which the system is in operation and there will be other cost saving benefits including a reduction in office storage space, stationery,postage and other costs. Because of the increased efficiency of the operation, Darn Plc also expect substantial increases in sales. The net cash inflows forecast from the installation of the new systems are as follows: At the end of year six, the company anticipate that the system will have to be scrapped and replaced with whatever is the latest technology at the time. There will be no residual value in the system at that point. The Board of directors have asked you to appraise the project to see how quickly it will pay back. You offer to appraise the project using discounted cash flow techniques, although Robin (one of the directors, who did a business course a few years ago) is distinctly sceptical about this approach and state: the good thing about payback is that you can see immediately how long it's going to take to recoup the cost of the investment. Discounted cash flow doesn't make any sense to me.'However, he agrees that it might just be helpful to see what the NPV of the project is,and he estimates the business cost of capital at 11%. a. What is corporate governance? List and discuss FOUR core values of the Organisation for Economic Co-operation and Development (OECD) corporate value framework Darn Plc should adopt to improve its corporate governance. Calculate the net present value of the project using 11% as the discount rate. Calculate the discounted payback period of the project. - Calculate the IRR of the project. - Calculate the discounted payback period of the project. Calculate the IRR of the project. e. Comment on the financial acceptability of the proposed investment based on the three appraisal methods used. Identify the strengths and weaknesses of the payback period, accounting rate of return (ARR) and internal rate of return (IRR).

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