Find Net Present Value (NPV)

West London Airport PLC is listed on the main market of the London Stock Exchange. The main asset of the business is West London Airport. Related to this are operations in property development within the airport grounds, retail and advertising operations, car parking, baggage handling and security.

Financial information for West London Airport PLC

Forecast financial information for West London Airport is given below for the current financial year ending 31st December 2015:

2015 forecast figures
Revenue per passenger Cost per passenger
Variable revenues and costs £ £
Aviation 80 35
Retail and Car parking 70 15

£million £million
Fixed revenue and costs 1,500 2,750
(i.e. unrelated to passenger numbers)

Passenger numbers for the financial year ending 31st December 2015 are forecast at 50million.

Financial forecasts for the five year period 2016 to 2020:

• Passenger numbers are expected to grow at a rate of 4% in each year from 2015 forecasted levels.
• An annual inflation rate of 1% applies to variable and fixed revenue per passenger figures.
• Variable costs per passenger and fixed costs are expected to increase at a rate of 3% per year on 2015 figures.

All rates above are compounded annually. Note however, these forecasts do not take account of the proposed investment project, which is detailed below.

Airport Expansion

The UK government has commissioned a review of airport expansion on London and will make a final decision in December 2015. The review, if approved, will allow existing airports to extend their opening hours to accommodate more flights. The outcome of the vote will clearly impact on airport expansion and the popularity of certain flight routes.

If the government decides to reject airport expansion in West London restrictions would in effect be introduced on air passenger travel by placing a maximum limit on the number of passengers who could travel in any given year. Without further runway expansion, a focus on larger aircraft will allow West London Airport to cope with a maximum of 55million passengers each year, and no more.

If the government decides to approve expansion of West London airport opening times will be extended and passenger numbers can be expected to increase beyond the 55million capacity for the foreseeable future.


Proposed terminal expansion project

During the past year West London Airport PLC has spent £250million to obtain planning permission to extend and improve the main terminal building, including a major refurbishment of the retail building and improved access to car parking facilities, to accommodate higher passenger numbers. The redevelopment is expected to lead to an increase in income from retail and car parking activities by encouraging existing passengers to spend more.

Work on the terminal expansion project would be undertaken during 2016. The total required investment in the project is £850 million. £600 million of this is payable up-front on 31st December 2015, with the remainder payable on completion of the building work on 31st December 2016. The newly refurbished facilities would be opened and fully operational on 1st January 2017.

The terminal expansion project is expected to have the following impact on West London Airport PLC’s revenues and costs:

• A 15% increase in both retail and car parking revenues per passenger at the beginning of 2017, affecting results from year-end 2017 onwards. No changes are expected in retail costs per passenger or to any other variable revenue or variable cost per passenger.
• An increase in fixed costs from £2,750 million to £3,000 million in 2017 in real terms, based on 2015 figures, and before adjusting for the general inflation rate. Fixed revenue is not expected to be affected by the project.

Taxation:

• Tax at 20% of business profits is payable during the year in which it arises.
• Due to the current economic climate and the government’s desire to stimulate investment, 100% first year tax allowances are available on capital investment at the time the payment is made.

Additional information for use in an investment appraisal of the proposed project:

• Any residual value of the capital investment should be ignored.
• Unless a specific date is given, all cash flows should be assumed to occur at the end of the financial year.
• The project is to be evaluated as at 31st December 2015, with cash flows assumed to continue until 31st December 2020, to reflect the expected life of the proposed investment.
• A nominal after-tax discount rate of 15% is considered to be appropriate for this project.
• The expected inflation rate for the overall economy is expected to be 2% per annum over the period of the project.
Question 1
Set up a capital budget showing the net present value of the investment project under both possible outcomes of the government’s decision on airport expansion using the information above. You should base your answers on nominal cash flows and discount rates.