One of the most successful products of Dallan plc, over recent years, is an electric motor known commercially as the ‘Powermite’. This motor is believed by management to have only a limited future market and should be superseded by a more modern one. Such a motor has been developed for the business by an independent consultancy business at a cost of £300,000, which is due to be paid on 31 December 20X0. Adecision now needs to be made on producing and marketing the new motor, which, if it is marketed, will be sold under the name ‘Dynamotor’. The basic proposal is to cease production and marketing of the Powermite at the end of 20X0 and to replace it with the Dynamotor.

The directors have agreed to base their decision on a net present value analysis of the possibilities.

Manufacture of the Dynamotor would take place using new, substantially automated plant. This plant would cost £1.2 million, payable when the plant would be installed on 31 December 20X0.

Assuming that the Powermite is phased out at the end of 20X0, sales of the Dynamotor are expected to be as follows:

Units 20X1 10,000 20X2 15,000 20X3 20,000 20X4 15,000 20X5 10,000 A selling price of £100 per unit is expected for the Dynamotor. Variable manufacturing costs are expected to be £40 per unit and incremental fixed costs £250,000 per annum.

If the Powermite is phased out at the end of 20X0, redundancies among production staff will take place on 31 December 20X0. The business will make redundancy payments totalling £120,000, on that date.
Management believes that, if the Dynamotor were not introduced, there would be a continuing demand for the Powermite until 20X3, assuming an £80 per unit price, as follows:
Units 20X1 4,000 20X2 3,000 20X3 2,000 The Powermite has an estimated £45 per unit variable cost element and has avoidable (incremental) fixed costs of £70,000 per annum.
Were the Dynamotor not to be introduced, and the Powermite retained, redundancy payments would be:
£
At 31 December 20X0 80,000 20X1 30,000 20X2 10,000 Plant currently used in Powermite manufacture is now fairly old and, whenever it were to be disposed of, would have a market value at, or close to, zero.
The directors estimate that the cost of capital will be 15% per annum for the foreseeable future.
Required:
On the basis of NPV, provide calculations that indicate whether the business should introduce the Dynamotor and discontinue the Powermite or continue Powermite production and not introduce the Dynamotor.AppendixLO1