Neqi plc has been producing reusable face masks for some time. The firm is considering to invest in new equipment, costing 5 million, to manufacture a new type of reusable face mask. The new version comes in a pack of 3 masks. Market research suggests scope to sell an additional 500,000 units per year (from the current level). The new number of units will be the same from year to year. The research fee amounted to 0.45 million and will be paid in year 1 of the project. The pricing structure (in British pounds) of a typical mask is as follows:

Price per unit XX

Cost per unit output

Variable cost per unit 1.50

Fixed overhead cost per unit 1.00

(2.50)

YY

The fixed overhead represents existing fixed costs of the mask factory. Capital allowance, on a reducing balance basis, is at 25 percent.

This article discussed the nature of face masks and a comparison of Neqis highly- regarded product and pricing compared to competitors offerings: https://www.theguardian.com/world/2020/oct/30/face-mask-test-which-best-at-limiting-spread-covid

The new production line is expected to operate for five years. It requires 0.5m of initial working capital which is expected to remain constant for the next five years. Working capital will not be recovered at the end of the project life. The equipment will have a residual value of 2 million at the end of the life of the project.

The new production line will be located in one of the companys buildings, being presently empty. This building was purchased at 6 million three years ago, for which an offer price of 2.5 million has recently been received. If the building is retained, the after-tax residual value is expected to be 3.5m after 5 years.

Neqis strategic planning division made the following forecasts for the average annual rates of inflation relevant to the project:

Mask prices 5% p.a.

Direct costs 3% p.a.

Fixed overhead costs 5% p.a.

Neqis real cost of capital for projects of similar risk is 8 percent. The general rate of inflation is 4.63 percent. The marginal tax rate is 30 percent.

Required: a. What is the projects actual (monetary) cost of capital?

b. Provide the reasons for the irrelevance of three cash flow items for project consideration.

c. Assess the financial viability of the proposed project using nominal (actual) cash flows. Monetary figures should be in million and intermediate computations should be in 2 decimal places.