Question 6 [20] - Ticor Ltd (NO EXCEL CALCULATIONS PLEASE)

Ticor Ltd has spent R20,000 researching the prospects for a new range of products. If it were to be decided that production is to go ahead, an investment of R240,000 in capital equipment on 1 January 2017 would be required. The accounts department has produced budgeted profit and loss statements for each of the next five years for the project. At the end of the fifth year the capital equipment will be sold and production will cease. The capital equipment is expected to be sold for scrap on 31.12.2021 for R40,000.

31.12.2017 31.12.2018 31.12.2019 31.12.2020 31.12.2021

Sales 400000 400000 400000 320000 200000

Materials 240000 240000 240000 192000 120000

Other variable costs 40000 40000 40000 32000 20000

Overheads 20000 20000 24000 24000 24000

Depreciation 40000 40000 40000 40000 40000

Net profit/(loss) 60000 60000 56000 32000 -4 000

When production is started it will be necessary to raise material stock levels by R30,000 and other working capital by R20,000. Both the additional stock and other working capital increases will be released at the end of the project. Customers receive one years credit from the company. The overhead figures in the budgeted accounts have two elements 60 per cent is due to a reallocation of existing overheads and 40 per cent is directly incurred because of the take-up of the project. For the purposes of this appraisal you may regard all receipts and payments as occurring at the year end to which they relate, unless stated otherwise. The companys cost of capital is 12 per cent. Assume no inflation or tax.

Required:

1) Use the net present value method of project appraisal to advise the company on whether to go ahead with the proposed project. (10)

2) Explain to a management team unfamiliar with discounted cash flow appraisal techniques the significance and value of the NPV method. (10)