1. OSB Limited (OSB) manufacture a range of children's bikes. The company are planning to introduce a new model of mountain bikes aimed at teenagers. Historically, the directors have used the payback technique for investment appraisal decisions. However, they have been advised to use the Net Present Value technique for this investment. Details of the investment are outlined in Exhibit 1A. EXHIBIT 1A PROJECT INITIATION DOCUMENT Project overview OSB has recently spent 500k developing the range of mountain bikes. The company will need to invest 2.5 million in manufacturing equipment to produce the new bikes. The equipment is expected to have a useful life of four years. At the end of the three years, it will be sold for 500k. The equipment will be depreciated on a straight line basis at a rate of 20% per annum. Forecast income and expenditure Based on market research, we expect to sell 50,000 units in the first year at a selling price of 150 per unit. Sales volumes are expected to increase by 5% per annum in each of the next three years. The selling price will increase at the same rate as general inflation, which is expected to be 3% per annum. The variable cost per unit will be 40 in the first year. This will then increase by 4% per annum in each of the next three years. Staff costs will be 1,200k in the first year and then increase by 2% per annum. Other overheads will be 700k in the first year and will increase by 4% per annum. Question 1 continues on the next page. 5R520021_2021_R Page 3/13 Question 1 continued. Other assumptions OSB pays Corporation Tax at a rate of 20%. Tax is paid in the year after the profit arises. The capital expenditure will be eligible for capital allowances at a rate of 18% reducing balance. There will be a balancing allowance or balancing charge in the year of disposal. OSB's 'real' cost of capital is 16.5%. General inflation is expected to be 3%. Requirements (a) Calculate the Net Present Value of the investment in the new range of bikes based on the information provided and advise the directors whether they should proceed with the investment. (18 marks) (b) Explain the impact on your Net Present Value calculation of an increase in the general rate of inflation. (3 marks) (c) Explain the advantages of using the Net Present Value technique to appraise investments instead of the payback method. (4 marks) Total: 25 marks