Appraise plc is considering manufacturing and developing a new product requiring a £2m investment. The following are estimates of costs and revenues for the first five years of the product’s life:

1 Forecast sales:

Year Quantities sold Selling price units £ per unit 1 5,000 250 2 15,000 230 3 22,000 200 4 15,000 200 5 5,000 200 2 New machinery will be bought at the start of the project at a cost of £2m. It is expected to have a resale value of £150,000 at the end of five years.

3 Labour costs will be £40 per unit in year 1, rising by £2 per unit in each succeeding year.

4 Materials costs will be £80 per unit for the first two years of production, rising by 10% in year 3, and by a further £6 in each of years 4 and 5.

5 Other costs will be £25 per unit. These are forecast to remain unchanged over the life of the project.

6 The cost of capital to the company is 6% p.a.

Relevant discount factors are:
Year Discount factor 1 0.943 2 0.890 3 0.840 4 0.792 5 0.747

(a) Evaluate the project by calculating the:
(i) Net present value (ii) Payback period.

(b) Advise the company whether it should proceed with the new product.

(c) If the company decides to manufacture the new product, it intends to use standard costing techniques as an aid to efficient management. Explain how these may be of benefit in controlling a company’s performance.