1. Charm plc, 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 favourable review by a popular PC magazine. Charm plc 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.

Calculate the internal rate of return of the proposed investment and comment on your findings.

Year 1 Year 2 Year 3 Year 4

Sales and production (units) 150,000 70,000 60,000 60,000

Selling price ( per game) 25 24 23 22

Financial information on Fingo for the first year of production is as follows:

Direct material cost 540 per game

Other variable production cost 600 per game

Fixed costs 400 per game

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. Although this production machine is expected to have a useful life of up to ten years, government legislation allows Charm plc to claim the capital cost of the machine against the manufacture of a single product. Capital allowances will therefore be claimed on a straight-line basis over four years, this equates to tax benefits of 60,000 p.a.

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

Calculate the net present value of the proposed investment and comment on your findings.