Question5
Kaye Limited has incurred expenditure of €300,000 over the past two years researching and developing a new product.
Making and marketing the product will require significant investment in specialised equipment and the directors must now decide whether to
further progress this project or not.
The following information is available;
A market research report for which the company paid €25,000 indicates that the new product has an expected life of four years. Sales of the
product are forecast as follows;
Year 1 2 3 4
Units 80,000 92,000 108,000 58,000
Unit Price €28 €22 €22 €18
Other relevant data:
Plant and Equipment required for the project would cost €2,400,000 and would have a residual value of €600,000 at the end of the
project. The company uses straight line depreciation.
Working capital investment will be €450,000. This will revert at the end of the fourth year.
The variable production cost will be €7 per unit and sales staff will be paid a commission of 10% on all sales revenue generated.
Fixed overheads related to project will be €860,000 per annum. This figure includes depreciation.
The company’s cost of capital is 8% per annum.
YOU ARE REQUIRED TO:
A. Prepare the relevant cash flows, calculate the Net Present Value (NPV) of the project and recommend if the company should undertake
the project. (12 Marks)
B. Calculate the Accounting Rate of Return (ARR) from the project. ( 8 Marks)
C. Explain why the Net Present Value (NPV) method of capital investment appraisal is considered to be theoretically superior to other methods
that are found in practice.
(5 Marks)
TOTAL: 25 MARKS
