Tota Limited manufactures motor vehicle components. It is considering introducing a new product. Tanagna Badree, the production director, has already prepared the following projections for this proposal:

2016

2017

2018

2019

($000)

($000)

($000)

($000)

Sales

8,750

12,250

13,300

14,350

Direct materials

1,340

1,875

2,250

2,625

Direct labour

2,675

3,750

4,500

5,250

Variable overheads

185

250

250

250

Depreciation

2,250

2,250

2,250

2,250

Fixed Overheads

1,012

1,012

1,012

1,012

Total expenses

7,712

9,387

10,512

11,637

Profit before tax

1,038

2,863

2,788

2,713

Corporate tax @ 30%

(311)

(859)

(836)

(814)

Profit after tax

727

2,004

1,952

1,899

Tanagna Badree has

recommended

to the board

that the

project is not worthwhile

because the cumulative after-tax profit over the four years is less than the capital cost of the project and hence the return on investment seems less than acceptable. As an assistant accountant at the company, you have been asked by Anala Largen, the chief accountant, to carry out a full financial appraisal of the proposal. She does not agree with Tanagna Badree's analysis and provides you with the following information.

The manufacturing plant will cost $9 million and is expected to be constructed on lands that the company bought some land three year ago.

That land mentioned above was purchased for $2.5 million three years ago in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for

$3 million. In four years, the after-tax value of the land is expected to be $3.5 million.

Working capital of $1,000,000 will be required at the beginning of the project.

The additional working capital will be recovered in full as cash at the end of the four-year period; At the end of the four-year period the equipment will be scrapped, with no expected residual value.

Tota Limited pays corporation tax at 30 per cent of profits.

The company's cost of capital is 17 per cent.

Required:

(a)Calculate the Net Present Value of the investment in the new product

(b)Calculate the payback period on the investment for new product.

(c)Calculate the discounted payback period on the investment for new product

(4 marks)

(d)Recommend whether the project should be accepted or not (with reasons).

(2 marks)

(e)Give three reasons why your analysis is different from that produced by Tanagna Badree, the production director.