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Question 6 A company manufactures internal communication system units for aircraft. It is planning to bid for a contract with a major aircraft manufacturer which requires 1,000 communication system units for its planes. The Sales Director is planning to bid at a price of 2,750 per unit The research and development costs for this communication system are expected to be in the region of 50,000 and will be incurred during the next year (for the purposes of investment appraisal these may be treated as year 1 cash outflows). The communication systems will then be manufactured over a four year period at a rate of 250 per year (treated as years 2-5 for the purposes of investment appraisal) The following estimates of costs have been made: Direct Labour -for the first conditioner 50 hours labour at a cost of 20 per hour will be required making a total cost of 1,000 for the first conditioner. Materials and components - 2,000 per air conditioner Fixed manufacturing costs - 70,000 per year (applicable in years 2, 3, 4 and 5) The factory manager considers that from his experience with similar units there will be a learning curve of 85% for factory labour. This learning will stop once 20 units have been produced. Thereafter the amount of time taken for the twentieth unit will be the amount of time taken for all subsequent units. The Learning Curve formula is Yx = axb Where: Y = Average time taken per batch to produce a cumulative number of batches = time required to produce the first batch = cumulative number of batches under consideration b = log of the rate of learning / log 2 a X The Company's cost of capital is estimated at 12%. The discount factors relating to this are as follows: Year 1 0.893 Year 2 0.797 Year 3 0.712 Year 4 0.636 Year 5 0.567 Page 10 of 12 Required: a) Calculate how many hours of labour will be required to make 1,000 units 7 marks b) Calculate the NPV of the product assuming that the bid of 2,500 is accepted 8 marks = c) Critically evaluate the level of risk and uncertainty involved in the assumptions made in arriving at the NPV of the project. In particular you should make reference to the strengths and weaknesses of the learning curve model 5 marks Total 20 marks