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Question 2 Wise Plastiline Ltd has spent 120,000 researching the prospects for a new product. The company's directors regard this capital project as risky because
Question 2 Wise Plastiline Ltd has spent 120,000 researching the prospects for a new product. The company's directors regard this capital project as risky because its implementation will require a modernization of the company's production site. An initial investment of 110,000 in capital equipment will be followed by three years with the following most likely estimates annual cash flows: f Annual sales (volume of 140,000 units of product multiplied by estimated sales price of 2.5 per unit) 350,000 Annual costs Labour Materials Other 40,000 170,000 93,000 303,000 Operating cash flows before depreciation and tax (303,000) 47,000 The equipment will have no second-hand value at the end of the three-year economic life of the project. The company's overall cost of finance is 9 per cent per annum. To ensure that all investments create shareholder value, the company use discounted cash flow methods in their investment appraisal process. The company's owner-manager, analyzing the project proposal, in interested in understanding the extent to which: (i) volume of annual sales and (ii) the cost of finance can change before the decision to accept the project switches to a decision to reject. Page 2 of 4 3/4 Assume that all cash flows arise at year ends. Ignore taxation and inflation. Required: (a) Assess the project using net present value (NPV) on the basis of the above estimates. (b) On the basis of the net present value, should the business go ahead with the project? (c) Give the required sensitivity analysis of the financial viability of the new project to variations in: (i) sales price and (ii) the cost of finance. (d) Briefly discuss the usefulness of the sensitivity analysis to the owner-manager in informing their decision on whether or not to go ahead with the proposed project, indicating any additional analysis that might be required. You must show computations and workings and state assumptions you have made clearly and neatly. Question 2 Wise Plastiline Ltd has spent 120,000 researching the prospects for a new product. The company's directors regard this capital project as risky because its implementation will require a modernization of the company's production site. An initial investment of 110,000 in capital equipment will be followed by three years with the following most likely estimates annual cash flows: f Annual sales (volume of 140,000 units of product multiplied by estimated sales price of 2.5 per unit) 350,000 Annual costs Labour Materials Other 40,000 170,000 93,000 303,000 Operating cash flows before depreciation and tax (303,000) 47,000 The equipment will have no second-hand value at the end of the three-year economic life of the project. The company's overall cost of finance is 9 per cent per annum. To ensure that all investments create shareholder value, the company use discounted cash flow methods in their investment appraisal process. The company's owner-manager, analyzing the project proposal, in interested in understanding the extent to which: (i) volume of annual sales and (ii) the cost of finance can change before the decision to accept the project switches to a decision to reject. Page 2 of 4 3/4 Assume that all cash flows arise at year ends. Ignore taxation and inflation. Required: (a) Assess the project using net present value (NPV) on the basis of the above estimates. (b) On the basis of the net present value, should the business go ahead with the project? (c) Give the required sensitivity analysis of the financial viability of the new project to variations in: (i) sales price and (ii) the cost of finance. (d) Briefly discuss the usefulness of the sensitivity analysis to the owner-manager in informing their decision on whether or not to go ahead with the proposed project, indicating any additional analysis that might be required. You must show computations and workings and state assumptions you have made clearly and neatly
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