Clyach plc has grown rapidly in recent years, to a large extent by expanding its product range. It is now necessary to evaluate another new product investment. The latest of these products has just completed the final stages of its trials and a decision must now be taken whether or not to proceed to the manufacture of the product. The products development has already cost 400,000 and the manufacture of the product will require an outlay of 1,500,000 on production facilities. This expenditure will have to be depreciated for tax purposes on a straight line basis over a ten year period, but the anticipated commercial life of product, given the level of product innovation in the industry, is only five years. The residual (re-sale) value of the production line is expected to be 250,000. The production line would be located in one of the companys existing factories with unused capacity. Based on the space occupied a cost of 40,000 will be allocated to be product by the companys management accounting system. The product is expected to sell for 35.00 per unit and sales of 80,000 units are anticipated for the first year. For years two to five 90,000 units are expected to be sold. The estimated variable cost per unit is 27.00 per unit, made up of 50 per cent raw material costs and 50 per cent labour costs. The fixed costs of production directly related to the product are expected to 100,000 per annum. Each product is also allocated an overhead charge of 8 per cent of lower costs through the management accounting system to allow for the recovery of R&D expenditure and head office expenses. It will be necessary to hold the equivalent of 15 per cent of expected sales in stocks of the finished product. Promotion and marketing expenditure prior to the introduction of the product will cost 70,000 and a further expenditure of 20,000 per annum will be required for each of the next five years. The company requires an expected return of 14 per cent on investments and pays tax at 30 per cent. a) Determine the net present value of the investment. Set out your calculations clearly and specify the critical assumptions.

b) Explain that is meant by sensitivity analysis, determine and discuss the sensitivity of the investments NPV to deviations in the expected price from the assumed value of 35 per unit.