Ring plc is evaluating the purchase of a machine to produce Product MP3, to which the following information applies:

Incremental fixed costs will be c25 000 per year. The machine will cost c850 000 and will last for four years. At the end of four years it is expected to have a scrap value of c40 000. Additional initial investment in working capital of c80 000 will be required. Annual sales of 150 000 units of Product MP3 are expected.
Ring plc has a nominal cost of capital is 10 per cent and a real cost of capital of 7 per cent. Taxation may be ignored.

(a) Calculate the net present value of the proposed investment and the sensitivity of this net present value to changes in the following project variables:
(i) Selling price (ii) Variable costs (iii) Sales volume.
Comment on your findings. Ignore inflation in this part of the question.

(b) Further investigation reveals that the proposed investment will be subject to the following specific inflation rates:

Calculate the net present value of the proposed investment using a nominal (money) terms approach.

(c) Briefly discuss ways in which the evaluation in part

(b) could be improved in order to support better decision-making.

Transcribed Image Text:

Selling price Packaging and production Components per box 11.00 3.00 5.50