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Beacon Chemicals plc is considering buying some equipment to produce a chemical named X14. The new equipment's capital cost is estimated at $100 million. If
Beacon Chemicals plc is considering buying some equipment to produce a chemical named X14. The new equipment's capital cost is estimated at $100 million. If its purchase is approved now, the equipment can be bought and production can commence by the end of this year. $50 million has already been spent on research and development work. Estimates of revenues and costs arising from the operation of the new equipment appear below: Sales price ($/litre) Sales volume (million litres) Variable cost ($/litre) Fixed cost ($000) Year 1 100 0.8 50 30 Year 2 120 1.0 50 30 Year 3 120 1.2 40 30 Year 4 100 1.0 30 30 Year 5 80 0.8 40 30 If the equipment is bought, sales of some existing products will be lost, resulting in a loss of contribution of $15 million a year, over the life of the equipment. The accountant has informed you that the fixed cost includes depreciation of $20 million a year on the new equipment. It also includes an allocation of $10 million for fixed overheads. A separate study has indicated that if the new equipment were bought, additional overheads, excluding depreciation, arising from producing the chemical would be $8 million a year. Production would require additional working capital of $30 million. For the purposes of your initial calculations ignore taxation. Required: (a) Deduce the relevant annual cash flows associated with buying the equipment. (b) Deduce the payback period. (c) Calculate the net present value using a discount rate of 8 per cent. (Hint: You should deal with the investment in working capital by treating it as a cash outflow at the start of the project and an inflow at the end.)
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