Question

Zannel plc is considering a new project to produce a revolutionary surveillance device. The initial capital costs of 300,000 will be paid immediately.

The project is expected to last five years. The sales director estimates that revenue in year one is expected to be 200,000 with a growth rate of ten percent per year. The gross profit is expected to be sixty percent for the duration of the project.

The companys policy is to use the straight-line depreciation method for the new projects asset over five years. At the end of this period, the asset will be scrapped. Assume that the disposal will not incur any cost nor generate any income.

Fixed overheads including depreciation for year one is forecast at 110,000. Fixed overheads excluding depreciation are to be increased at a compound rate of five percent per year. Capital allowances are to be taken at 25% of the net book value at the start of the year.

The marginal tax rate is twenty percent. Taxes are considered one year in arrears. The cost of capital for the companys existing projects is ten percent, which the sales director suggests to adopt in assessing the new project.

Required:

d) Critically comment if the CAPM has any bearing on the sales directors suggestion.