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Capital Budgeting


Qantas’s wishes to further develop their frequent flyer loyalty program by introducing a range of leisure facilities to their members. It is considering investing in one of two projects, developing a golf course on the Gold Coast or purchasing a casino in Perth. The golf course on the Gold Coast requires an initial investment now of $ 1.8m and further investments at the end of years 1, 3 and 5 of $ 1.2 m each. In addition, it will also incur working capital expenses at the beginning of the project of $0.4 m and recover these at the end of year 8. The Golf course will generate cash inflows of $ 0.8 m starting the end of year 1, $1.6m each in years 2, 3 and 4 and $ 1.8m each through years 5 to 8. At the end of year 8 the course will be sold for $ 0.6m. Qantas is able to claim an annual depreciation of $0.15m from years 1 to 5 and pays tax at 30%. The casino in Perth requires one-off initial investment of $ 5m now and will generate cash inflows of $0.6m starting end of year 1, $1.8m each in years 2, 3 and 4 increasing to $ 2m every year for the next 4 years. The Casino will be sold at the end of this for $ 0.4m; Qantas will not qualify for any depreciation on this project and will pay tax at 30%. a) Calculate the Net Present Value (NPV) for each of the two investment options, assume that the WACC for Qantas is 10%. (Do NOT use the WACC you have calculated in the earlier questions. 10 marks) b) Which investment will you recommend for Qantas? (5 marks) c) Qantas is also considering investing in the Venezuelan oil industry as an alternative. Given the recent economic hardships in Venezuela (See Source 5), Venezuelan government is looking to privatise portions of the country’s oil industry. Venezuelan government offered to sell one oil field to Qantas. Assume that the NPV for the oil field project is higher than that of the gold course and the casino under the same WACC of 10%. Should Qantas invest in the oil field instead of the gold course and the casino? What could be the potential dangers? What adjustments in terms of discount rate would you recommend? (Discuss the adjustment directions and the reasons, no calculations needed, 10 marks)