Plato Pharmaceuticals Ltd has invested 300,000 to date in developing a new type of insect repellent. The repellent is now ready for production and sale and the marketing director estimates that the product will sell 150,000 bottles per annum over the next five years. The selling price of the insect repellent will be 5 per bottle and the variable costs are estimated to be 3 per bottle. Fixed costs (excluding depreciation) are expected to be 200,000 per annum. This figure is made up of 160,000 additional fixed costs and 40,000 fixed costs relating to the existing business which will be apportioned to the new product.

In order to produce the repellent, machinery and equipment costing 520,000 will have to be purchased immediately. The estimated residual value of this machinery and equipment in five years time is 100,000. The company calculates depreciation on a straight-line basis.

The company has a cost of capital of 12 per cent. Ignore taxation.

Required

(a) Calculate the net present value of the product.

(b) Undertake sensitivity analysis to show by how much the following factors would have to change before the product ceased to be worthwhile:

(i) the discount rate

(ii) the initial outlay on machinery and equipment

(iii) the net operating cash flows

(iv) the residual value of the machinery and equipment

(c) Discuss the strengths and weaknesses of sensitivity analysis in dealing with risk and uncertainty.

(d) State, with reasons, whether or not you feel the project should go ahead.