) Tango plc is considering launching a new product. It bought the patent to manufacture the item a year ago for 20,000 and could now sell it for 10,000. (The taxation effects of the purchase or sale of a patent should be ignored). Preliminary market research, costing 5,000, has added to the optimism about the product and a full capital appraisal is now to be undertaken. It is anticipated that sales in the first year would be 10,000 units, 20,000 in year 2, rising to 30,000 per annum in years 3 to 5. The company plans to stop production at that point. The patent would have no residual value.

The sales price would be 2.20 per unit in the first year and it is anticipated that it would then rise by 4% per annum for the life of the product. The current price of the relevant materials for the first years sales is 50p per unit and this cost is expected to rise by 2% per annum. Current salaries estimates are 10,000 per annum and wage inflation is expected to be 3% per annum for the life of the project. Other costs are budgeted to be 30p per unit in todays money and will rise by the general level of inflation estimated at 2.5% per annum.

A new machine would have to be purchased to manufacture the product. It would cost 100,000 and could be purchased immediately. It would last the 5 years of the products expected life and could then be sold for 10,000 at todays money. The price of machinery is expected to rise in line with the general rate of inflation.

You may assume that the tax payments will occur in the year the related profits are made and that cash flows will occur at the end of the relevant year. There would be no other alteration to the cost structure of the firm. The market determined cost of capital for this project is 12%.

Required: Advise Tango plc whether it should go ahead with production on financial grounds. Support your answer with all the necessary calculations. You must show all your workings. Ignore the effect of taxation.