Firm "AAB" is considering investing in the production of a new product X. To this end a preliminary market research is undertaken that costs 400,000 in year 0. The financial management of the firm expects that unit sales of the new product X will be as follows: 75,000 units in year 1, 70,000 units in year 2, 120,000 units in year 3, 110,000 units in year 4, and 80,000 units in year 5. Production of the new product X will require 1.5M (M=million) in net working capital (NWC) to start, which will be completely recovered at the end of the 5 years. Total fixed costs are 800,000 per year, variable production costs are 300 per unit, and the units are priced at 400 each. The equipment needed to begin production has an installed cost of 25M and can be depreciated by using the straight-line depreciation method. At the end of the 5 years, this equipment can be sold for 20 per cent of its acquisition cost. Firm "AAB" is in the 35 per cent marginal tax bracket and has a cost of capital of 15 per cent.

a) Does the market research cost influence the project appraisal decision?

(5%)

b) Calculate the Earnings Before Interest and Taxes (EBIT) in each year, from year 1 to year 5.

(10%)

c) Calculate the Net Cash Flow (NCF) in each year, from year 0 to year 5.

(10%)

d) Calculate the Net Present Value (NPV) of the project at the discount rate of 15 per cent. Should the project be accepted according to the NPV method?

(10%)

e) Explain by means of concrete examples the difference between a "sunk cost" and an "opportunity cost".

(5%)