Hippy Ltd. have been approved for a major project to manufacture a product for a large company in Europe which sells motor vehicles. It is concerned that its product portfolio is not as up to date in the electric and hybrid technology as the other car part manufacturers.

The project is due to last for four years. They will supply a widget component to the European company and if it goes well, they will look into additional product offerings.

As the financial accountant you have been asked to review the following details relating to the upcoming project and report back to the directors whether in your opinion you feel that this project will be worthwhile or not.

o Three million products will be required for each of the first two years. This requirement will reduce by one million in year three and two million in year four.

o The selling price of the product will be 12 per component each year.

o In order to manufacture the component a presently unoccupied building, which is owned by Hippy, will be occupied. Demand for property is strong at present and it is estimated that Hippy could let the building for rent of 750,000 per annum in each of the four years.

o New machinery costing 7.5m. will be purchased immediately and this is expected to have a scrap value of 1m at the end of the fourth year.

o Working capital amounting to 1m. will be required to fund materials required in manufacture.

o Direct materials and variable labour costs of production have been estimated at 3 and 5 per unit respectively.

o The cost accounting department has allocated 150,000 per annum to the new contract. These are existing fixed overheads which will be reallocated as a result of the presently empty building being occupied.

o The machinery will have a maximum capacity of two million units per annum and Hippy has identified another manufacturer who will supply any excess components to Hippy at 7 per unit.

o Distribution costs will amount to 2.5m. per annum.

You are required to:

(a) Using Hippy Ltds current cost of capital of 13%, calculate the net present value of the investment and advise if Hippy Ltd. should accept or reject this project explaining your decision.