Artmorge Analytics Inc (AAI), a software business, has developed a new fitness monitoring tracker (the worldbeater), which the Board of Directors is planning to launch in the near future, subject to a successful outcome of its capital investment appraisal process. The Board of Directors financially appraises projects using the NPV and IRR methods. AAI has a weighted average cost of capital of 16%. Sales of the worldbeater are expected to be huge following some very positive trade press reviews. It is anticipated that the worldbeater will have a four-year lifecycle. The Board of Directors has already conducted detailed market research at a cost of $125,000. Results from this suggest the following sales volumes and prices over the four years.

Tracker Volume Price

Year 1 90,000 45

Year 2 80,000 42

Year 3 70,000 38

Year 4 60,000 36

AAI does not intend to hold any inventory so the production volumes will equal the sales volumes each year. Producing and selling the worldbeater will necessitate increased investment in working capital at the start of each year at 8% of revenue for that year.

Direct materials and other variable costs for the worldbeater tracker for the first year of production are $22. This cost is expected to rise by inflation of 4% per annum thereafter.

Incremental fixed costs are expected to be $635,000 in the first year, rising by 2% per annum thereafter. Advertising costs to stimulate demand are expected to be $500,000 in the first year of production, $150,000 in year 2 and $100,000 in year 3. No advertising costs are expected in the fourth year of production.

AAI requires to invest $1,200,000 in new robotics machinery to produce the worldbeater tracker. The machinery will be sold for scrap at the end of the four years for $50,000. AAI can claim capital allowances on a straight-line basis over four years and pays corporate taxation at a rate of 24% of profits one year in arrears.

Required:

1. Calculate the net present value of the proposed investment and comment on your findings. Show all workings.

2. Calculate the internal rate of return of the proposed investment and comment on your findings. Show all workings

3. Critically discuss the reasons why the net present value investment appraisal method is preferred to other investment appraisal methods such as payback, return on capital employed and internal rate of return.