Thunder plc has just developed a new product to be called the Lightening and is now considering whether to put it into production. The following information is available:

(i) Costs incurred to date in the development of Lightening amount to $\$ 480,000$.

(ii) Production of Lightening will require the purchase of new machinery at a cost of $\$ 2,400,000$ payable immediately. This machinery is specific to the production of Lightening and will be obsolete and valueless when production ceases. The machinery has a production life of four years and a production capacity of 30,000 units per annum.

(iii) Production costs of Lightening (at year 1 prices) are estimated as follows:

In addition, fixed production costs (at year 1 prices), including straight-line depreciation on plant and machinery specific to this project, will amount to $800,000 per annum.

(iv) The selling price of Lightening will be $80.00 per unit (at year 1 prices). Demand is expected to be 25,000 units per annum for the next four years.

(v) The retail price index is expected to be at $5 \%$ per annum for the next four years and the selling price of Lightening is expected to increase at the same rate. Annual inflation rates for production costs are expected to be as follows:

(vi) The company's cost of capital in money terms is expected to be $15 \%$.
You may ignore the effects of taxation.
Unless otherwise specified all costs and revenues should be assumed to arise at the end of each year.

Required:

Calculate whether Thunder plc should produce Lightening on the basis of the information above.

Transcribed Image Text:

Direct material $ 8.00 Direct labour 12.00 Variable overheads 12.00