Cow Clocks Limited (CCL) is operating at near capacity and is examining the possibility of expanding production by introducing a new production line (the project). CCL sells inexpensive stopwatches and has been making good profits in this industrial sector for many years. Demand is now approaching 400,000 stopwatches per annum, and that is the current maximum capacity. The Board of Directors anticipates an increase in demand over the next few years as more and more people take up competitive running for fitness purposes. If the Board goes ahead with the project, part of the factory space that is currently rented out to some local small businesses would require to be used. These small companies pay 50,000 per annum in rents for the space. The new machinery required for the project would cost 320,000 and would incur further shipping and installation charges of 80,000. Taxation depreciation allowances are available on a straight-line basis over five years on all of this expenditure. The company does not expect any salvage value at the end of the project. The new production line will require an extra manager to oversee the smooth introduction of the extra capacity in the first year. The manager will come from another part of the company at a salary of 60,000. The existing position is not being filled and the manager will go back to it at the end of the first year. The space in the factory currently rented to the small businesses would need to be converted into a form suitable for the new production line, at a cost of 25,000, which would be treated as an immediate tax-deductible expense. The Board would aim to spend an extra 80,000 a year for four years on a marketing campaign to keep demand high and stimulate new demand for the companys stopwatches. The new machinery would require maintenance expenditure of 12,000 per annum for the first five years and then 17,000 a year for the next two years. The new production line would necessitate an additional 60,000 in working capital to support the expected demand. Working capital levels are expected to remain at this level through to the end of the project. The new production line is expected to generate an increase in sales of 50,000 stopwatches in the first year, rising to 70,000 stopwatches in year two and 80,000 stopwatches in year three, reaching 90,000 stopwatches in years four and five. Year six will be the peak year, where the capacity of the new production line will be reached and mean that an extra 100,000 stopwatches are sold. The final year will see a fall off and extra sales are expected to be 30,000 stopwatches in the final year. The selling price of a stopwatch is 9.25 and the variable costs in producing it are 6.00. The selling price and variable costs are expected to remain the same for the seven years of this project. Company policy is to allocate fixed overheads to every project. There are no incremental fixed overheads associated with this new project but 10,000 of the existing fixed overheads of 100,000 will be allocated to this new project. The companys weighted average cost of capital is 11%. CCL pays corporate taxation at a rate of 21% and this is payable in the same year that it is incurred. 7

Required: 1. Calculate the NPV of the project and recommend based on your calculation whether CCL should proceed with the expansion? (11 marks)