Robo Clean Co is a recently established innovation company. It currently has one product on the market, the Robovac, a robotic floor cleaner. This has been extremely successful. The company is currently developing a new robotic cleaner called Robomum that vacuums, dusts and presses.

To date $120,000 has been spent on developing the product. The company has also incurred $250,000 of market research costs, although the invoice for these costs has only just been received and will be paid in January.

Since the set-up costs are substantial, a final decision now needs to be made as to whether it is viable to manufacture and sell Robomum. The following revenues and costs have been estimated:

1. A new factory, to be used solely for the production of Robomum, will need to be built. This will take nearly a year to build and is expected to cost $1175 million in total, payable in two instalments. The first instalment of

$6m will be paid at the start of the building work and the second instalment for the remaining balance will be paid when the building work has been completed at the end of the year.

2. Robo Clean Co will immediately enter into a one-year contract with a project management company, who will oversee the building of the factory. The total cost of this during the year will be $250,000.

Two production lines will need to be installed in the factory at a further cost of $1,500,000 payable at the end of the build in one years time.

3. The machinery for the production of Robomum also needs to be built-to-order and is expected to cost $25m, payable in one years time. Its terminal value is nil. Depreciation will be charged as soon as production commences (as soon as the build finishes in one years time) at 10% per annum on a straight-line basis. Maintenance costs for the machinery are estimated at $250,000 per annum.
4. Production and Sales will commence in the year following the build. Sales quantities and prices for Robomum are expected to be as follows:

Years 1		2	3 & 4	5 to 9
Sales volume (000 units)	5	10	(each year) 30	(each year) 50
Sales price ($)	1,000	800	700	500

It is anticipated that by the beginning of year 10, a new robotic helper will have replaced Robomum, hence there will be no further sales.

5. Material costs for Robomum are estimated at $125 per unit.
6. Labour costs are estimated at $100 per unit.
7. Fixed production overheads on the new factory are estimated at $240,000 per annum. Variable production overheads are expected to be $50 per unit.
8. Head office costs of $45m per annum will be allocated to Robomum when production commences. Of these costs, only $37m is incremental.
9. The introduction of Robomum is expected to adversely affect sales of Robovac. It is thought that, for every two units of Robomum sold, one unit of Robovac will be lost. Robovac is currently sold for $150 per unit and generates a net cash flow of $50 per unit.
10. The companys cost of capital is 5%.
11. Assume that all cash flows occur at the end of the year, unless stated otherwise.
12. All workings should be in $000, to the nearest $000.

Required:

1. Using the discount tables, calculate the net present value (NPV) of the project at the companys cost of capital. Conclude as to whether Robo Clean Co should proceed with the Project.

2. Explain the main principles to differentiate between relevant and irrelevant costs for investment appraisal. Wherever possible, use the costs of Robomum to illustrate your answer.

3. Calculate the Payback (Simple & Discounted) of the Project.

4. Calculate the IRR of the Project.

5. Calculate the Profitability Index PI of the following Projects and state which Project to be undertaken and why.

PV of Inflows Investment

Project A $5m $30m

Project B $3m $15m