Rainy plc is considering investing in a machine to manufacture a new line of umbrellas. The following data has been assembled in respect of the investment:

(1) Market research has just been carried out at a cost of £20 000. The study estimated the revenue from the new umbrella and the effect on existing products to be:

(3) Fixed costs such as rent, rates, etc. which are unaffected by the investment will be £50 000 per year.
(4) The machine to be used will cost £120 000 payable immediately. It will be depreciated using the straight line method. The residual value will be nil.
(5) The cost of capital is 12%.
Required:

(a) Calculate the NPV of the project. Should Rainy ple invest? (10 marks)

(b) Briefly, explain why the NPV method is superior to the ROCE and Payback approaches.

Transcribed Image Text:

Year 12 2 3 4 Revenue from new umbrella Lost revenue from existing products 000s 100 120 140 120 000s 30 25 10 (2) The annual variable costs associated with expected sales and savings from reduced production of existing products are expected to be: Year 1 234 Variable costs of making the new umbrella 000s 60 Costs saved on existing products 000s 20 65 70 60 15 - 5