17 Lois Technology Company (LTC) designs and sells rheometers for material analysis applications. The company is evaluating Project IR, a proposal to develop an interfacial rheometer, the CIR100 at a cost of 750,000. LTC has already carried out a feasibility study costing 42,000 researching the viability of the new product. The study confirmed that the CIR100 would be viable however would likely have a short product lifecycle due to rapidly changing technology. Informed by the study and knowledge of the market, production and sales of the CIR100 are forecast as follows: Year 1 2 3 4 5 Sales Units per Year 20 40 65 35 20 The selling price of the CIR100 will be 23,000 per unit. The variable cost is forecast at 13,250 per unit. The CIR100 can be manufactured within the existing factory without any increase in overheads, but the company will need to recruit an additional Sales Executive 44,000 per year and an administrator at 19,500. The Sales Director, who earns 95,000 per year, estimates that he will spend up to 15% of his time marketing and selling the new product. The launch of the CIR100 will result in a 60% drop in existing sales of a similar product, the CDCA100 product, which generates 45,000 contribution per year and was forecast to remain in production for the next five years at the same levels of annual contribution Customers pay in arrears and LTC estimates that the project will require an investment in working capital at the beginning of each year amounting to 8% of sales revenue for that year. The working capital will unwind at the end of the project as customers pay their bills. LTC pays tax of 25% per year in the same year in which the taxable profit occurs. Liability to tax is reduced by capital allowances on machinery purchased as part of the project at a cost of 450,000, which LTC can claim on a straight-line basis over the five-year life of the proposed investment. The new machine is expected to have zero ecran value at the end of the nmiert 15:26 E remaining LTC pays tax of 25% per year in the same year in which the taxable profit occurs. Liability to tax is reduced by capital allowances on machinery purchased as part of the project at a cost of 450,000, which LTC can claim on a straight-line basis over the five-year life of the proposed investment. The new machine is expected to have zero scrap value at the end of the project. LTC uses a nominal after-tax cost of capital of 11% for investment appraisal purposes. Q8(a). Use an appropriate appraisal technique to recommend whether LTC should proceed with proposed investment in Project IR. (18 marks) Q8(b). LTC has received information suggesting that the cost of developing and selling the new instrument might be considerably more than 750k. Calculate and interpret the sensitivity of the Project IR investment proposal to a change in the amount of the initial investment. (2 marks) Besides Project IR, LTC is also considering two further investments, neither of which are divisible: Project CA (1.5m) and Project ST (2.0m). LTC's available capital is restricted to 4m because it cannot raise further external funds. Q8(c). Explain in no more than 200 words how capital rationing applies to LTC, and how the company should formulate an optimal investment schedule in the context of the restrictions on its capital. (5 marks) Jess has an opportunity to buy an old horsebox which if renovated could be used as a mobile shop and allow her to travel to specialist markets to sell her range of bespoke, handmade cushions. The purchase price and on work would cost 27,000. She charges 30 for each cushion and the cost of materials and other Q8(c). Explain in no more than 200 words how capital rationing applies to LTC, and how the company should formulate an optimal investment schedule in the context of the restrictions on its capital. (5 marks) Jess has an opportunity to buy an old horsebox which if renovated could be used as a mobile shop and allow her to travel to specialist markets to sell her range of bespoke, handmade cushions. The purchase price and renovation work would cost 27,000. She charges 30 for each cushion and the cost of materials and other variables are 12. The annual cost for overheads is budgeted at 22,000. Based on her previous sales and knowledge of the markets she has estimated the following demand: Year 1 Year 2 Year 3 Year 4 Year 5 Number of Cushions 1,250 1,400 1,650 2,500 2,100 Q8(d). Calculate the ARR for the project. (3 marks) Q8(e). The only non-cash expense in the projected overheads for Jess's Horsebox is depreciation of 3,750. Calculate the payback period for the investment. (2 marks)