Charm Inc., a software company, has developed a new game, 'Fingo', which it plans to launch in the near future. Sales of the new game are expected to be very strong, following a favorable review by a popular PC magazine. Charm Inc. has been informed that the review will give the game a 'Best Buy' recommendation. Sales volumes, production volumes and selling prices for 'Fingo' over its four-year life are expected to be as follows:

Advertising costs to stimulate demand are expected to be $ 650,000 in the first year of production and $100,000 in the second year of production. No advertising costs are expected in the third and fourth years of production. Fixed costs represent incremental cash fixed production overheads. 'Fingo' will be produced on a new production machine costing $800,000. Tax allowable depreciation will be claimed on a reducing balance basis at a rate of 25%. The machine will have a useful life of four years at the end of which no scrap value is expected.

Charm Inc. pays tax on profit at a rate of 30% per year and tax liabilities are settled in the year in which they arise. Charm Inc. uses an after-tax discount rate of 10% when appraising new capital investments. Ignore inflation.

Required:

a) Net cash flows from year 1 to year 4 (calculation and analysis)

b) Payback period of the proposed investment (calculation and analysis)

c) The accounting rate of return of the proposed investment (calculation and analysis)

d) The net present value of the proposed investment (calculation and analysis)

e) Analysis (1000 words): Discuss the reason why the net present value investment appraisal method is preferred to other investment appraisal methods such as payback, accounting rate of return and internal rate of return

Year 1 2 3 4 150,000 70,000 60,000 60,000 Sales and production (units) Selling price ($ per game) $25 $24 $23 $22 Financial information on "Fingo" for the first year of production is as follows: Direct material cost $5.40 per game Other variable production cost $6.00 per game Fixed costs $4.00 per game