Advanced : Learning curve and the calculation of NPV RS p.l.c. manufactures domestic food mixers. It is investigating whether or not to accept a three-year contract to make a new model for sale through a supermarket chain. The contract uses skilled labour which cannot be increased above that currently available and AS p.l.c. will receive a fixed price of £42 per mixer for all the mixers it can produce in the three-year period. The following estimates have been made:

The factory manager knows from experience of similar machines that there will be a learning effect for labour He estimates that this will take the form:

where y = average labour hours per unit a = labour hours for first unit x = cumulative product1on He estimates that the first mixer will take 1 0 hours to produce and that the fixed amount of labour available will enable 5000 mixers to be produced in the first year Apart from the cap~al investment, all cash flows can be assumed to arise at year ends.
The company has a cost of capital of 15% .
You are required

(a) to calculate the NPV of the proposed contract: (16 marks)

(b) to state what other factors need to be considered before a final decision is made.

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Capital investment Additional overhead Materials Labour 50000 payable now, with nil scrap value. 25000 per annum. 30 per mixer. 6 per hour.