QUESTION 1

Geko PLC is considering the manufacture of a new product. The company has existing buildings that could be sold to buyers for R 120,000. The balance sheet records the building as having a value of R 60,000. The new product, which has a life of 5 years, will require installation of sophisticated machinery. This will cost R 200,000. At the end of its life, the machine can be sold for R 10,000. Depreciation should be charged on the machine at 25 per cent using the reducing balance method. Demand for the new product is expected to be 4,000 units in year 1 and 7,000 units in each of years 2 to 5. The sale price will be R 110 per unit; direct labour, direct material and variable overheads will cost R 60 per unit and additional fixed expenses of R 50,000 per annum will be incurred. An investment in working capital is required in year 0 of R 75,000. This will be increased to R 100,000 in year 1. No further increases are required over the life of the project. Assume that the company pays corporation tax at 24 per cent on its taxable profit a year after the end of the year and requires a rate of return of 10 per cent per annum after tax on this type of project.

Use NPV to determine whether the project is acceptable or not. Show all your calculations and state assumptions (if any) that has been made.