Provide appropriate answers for ALL questions. (Original content)
Digg is a manufacturing company that is considering the development of a new product. The company has a factory building that is nearing the end of its useful life and that is presently unoccupied. The directors are considering a project that would put the factory to use for the remainder of its life. Digg is considering the launch of a new product that could be manufactured in the factory space. The following cash flows have been predicted for this project: Investment in machinery $2.0m Demand in first year 500,000 umits Demand in each of years 2-5 1,500,000 units Selling price per unit E20.00 Materials cost per unit E8.00 Additional labour E800,000 per year The investment in machinery will occur at the beginning of year 1. All other cash flows will occur at the end of the year in question. These figures reflect the "most likely" outcome demand for this product. There is a 70% probability that the product will generate this degree of demand. There is a 30% "least likely" probability that demand will be 200,000 units in the first year. In that case the project will be abandoned. The labour will be provided by a specialist subcontractor who will require an unbreakable five year contract, The machinery purchased for this project will be disposed of for a negligible amount that will barely cover the costs of its dismantling and removal. The product requires a specialised alloy that is difficult and expensive to obtain because it creates toxic by-products. Digg could buy a furnace that would enable it to manufacture the alloy in- house. The furnace would have a five year life and could be located in the factory that will be used for this project. Buying the furnace will reduce the cost of materials by $5.00 per unit. The furnace itself will cost El.2m, but it will have to be decommissioned on disposal by a specialised recycling company once it has been exposed to the by-products and this will cost a further El.5m (1) Calculate the net present value of the project, using a discount rate of 9%, on each of the following bases: (a) Digg does not invest in the furnace and the "most likely" demand is achieved. (b) Digg invests in the furnace and the "most likely" demand is achieved. (c) Digg does not invest in the furnace and the "least likely" demand is achieved. (d) Digg invests in the furnace and the "least likely" demand is achieved. [8](i) Assuming a rate of interest of 6% pa, calculate the present value as at 1 January 2008 of the following annuities, each with a term of 25 years: (H) an annuity payable annually in advance from 1 January 2009, initially of E3,000 pa, and increasing by $500 pa on each subsequent 1 January (b) an annuity as in (i), but only 10 increases are to be made, the annuity then remaining level for the remainder of the term. [6] (Hi) An investor is to receive a special annual annuity for a term of 10 years in which payments are increased by 5% compound each year to allow for inflation. The first payment is to be (1,000 on 1 November 2009. Calculate the accumulated value of the annuity payments as at 31 October 2026 if the investor achieves an effective rate of return of 4% per half year. [4] [Total 10]
