Question 3(20)

As manager of your division you are currently considering a strategic investment opportunity. Your research reveals that the equipment including installation and transport needed for the project will cost R150000. The project will have a 4 year life span after which time it is expected that one can sell the current equipment for R40000. Equipment is depreciated straight line over the next 3 years.

On your request marketing department did some research and they indicated that they anticipate that the project will generate sales of 1800 units in each of the 4 years. It is calculated that production cost per unit will be R35 each and that products will sell at R45 each in the first year. Given that costs and sales prices should be adjusted for inflation the expected inflation rate is estimated to be 4.5% for the second year 3.0% for the third year and 5.0% in the fourth year. Assume that production inflation will be similar to the inflation as indicated.

Additional Net Operating Working Capital needed is expected to be 9% of sales for year 1; it is expected that working capital needs in each of the years following will change in line with general inflation expectations.

Additional Information:

It is expected that the project income will be taxed at a rate of 30%. The cost of capital for the project is 16%.

Fixed cost other than depreciation is estimated to be R9000 for the first year and needs to change in each of the years following line with general inflation expectations.

Based on the information above and considering the project in terms of NPV and MIRR analysis would recommend investment in the project?