Stay Safe plc. is a leading producer of personal protective equipment (PPE). The managing director of the company is currently evaluating a new product-transparent face mask. Production facilities for the transparent face masks would be set up in an unused section of the company's main plant. Machinery with an estimated cost of 500,000 would be purchased, and shipping costs to move the machinery to the plant would total 20,000. Installation charges would add another 50,000 to the total equipment cost. The machinery has a remaining economic life of 4 years, and attracts annual capital allowances of 25% on a reducing balance basis. The machinery is expected to have a salvage value of 100,000 after 4 years of use. The purchase of the machinery will be financed partly by a bank loan and partly by retained earnings. Interest payments are estimated at 20,000 annually. The company's inventories (raw materials, work-in-process, and finished goods) would have to be increased by 10,000 at the time of the initial investment. The section of the main plant where the transparent face masks production would occur has been unused for several years, and consequently it has suffered some deterioration. Last year, as part of a routine facilities improvement program, Stay Safe pic spent 100,000 to rehabilitate that section of the plant. Management expects to sell 425,000 packs of the new transparent face masks in each of the next 4 years, at a price of 2.50 per pack, of which 1.70 per pack would be needed to cover fixed and variable operating costs. In examining the sales figures, the sales manager expressed concern that the transparent face masks project would cut into the firm's sales of existing face visors, causing the net reduction in sales of 20,000. The corporate tax rate is 40 percent, and Stay Safe's overall cost of capital (in real terms) is 15 percent Required: Define the term "incremental cash flow." (1 mark) Explain whether interest expenses should be included in the cash flows. (2 marks) Explain whether the 100,000 spent to rehabilitate the plant should be included in the analysis. (2 marks) Calculate the project's NPV and IRR (you should use an upper discount rate of 30% in your IRR calculation) and advise whether the project should be undertaken. Show your workings (18 marks) Evaluate and compare the NPV and IRR methods of investment appraisal from the perspective of Stay Safe Pic's shareholders. (7 marks) (Total: 30 marks) iv. Stay Safe plc. is a leading producer of personal protective equipment (PPE). The managing director of the company is currently evaluating a new product-transparent face mask. Production facilities for the transparent face masks would be set up in an unused section of the company's main plant. Machinery with an estimated cost of 500,000 would be purchased, and shipping costs to move the machinery to the plant would total 20,000. Installation charges would add another 50,000 to the total equipment cost. The machinery has a remaining economic life of 4 years, and attracts annual capital allowances of 25% on a reducing balance basis. The machinery is expected to have a salvage value of 100,000 after 4 years of use. The purchase of the machinery will be financed partly by a bank loan and partly by retained earnings. Interest payments are estimated at 20,000 annually. The company's inventories (raw materials, work-in-process, and finished goods) would have to be increased by 10,000 at the time of the initial investment. The section of the main plant where the transparent face masks production would occur has been unused for several years, and consequently it has suffered some deterioration. Last year, as part of a routine facilities improvement program, Stay Safe pic spent 100,000 to rehabilitate that section of the plant. Management expects to sell 425,000 packs of the new transparent face masks in each of the next 4 years, at a price of 2.50 per pack, of which 1.70 per pack would be needed to cover fixed and variable operating costs. In examining the sales figures, the sales manager expressed concern that the transparent face masks project would cut into the firm's sales of existing face visors, causing the net reduction in sales of 20,000. The corporate tax rate is 40 percent, and Stay Safe's overall cost of capital (in real terms) is 15 percent Required: Define the term "incremental cash flow." (1 mark) Explain whether interest expenses should be included in the cash flows. (2 marks) Explain whether the 100,000 spent to rehabilitate the plant should be included in the analysis. (2 marks) Calculate the project's NPV and IRR (you should use an upper discount rate of 30% in your IRR calculation) and advise whether the project should be undertaken. Show your workings (18 marks) Evaluate and compare the NPV and IRR methods of investment appraisal from the perspective of Stay Safe Pic's shareholders. (7 marks) (Total: 30 marks) iv
