Vernon Co introduced a new product, PD to its range last year. The machine used to mould each item is a bottleneck in the production process meaning that a maximum of 7000 units per annum can be manufactured.

The PD product has been a huge success in the market place and as a result, all items manufactured are sold. The marketing department has prepared the following demand forecast for future years as a result of feedback from customers.

Year	1	2	3	4
Demand (units)	8000	10000	12000	6000

The directors are now considering investing in a second machine that will allow the company to satisfy the excess demand. The following information relating to this investment proposal has now been prepared:

Initial investment	$30000
Maximum additional output	7000 units
Current selling price	$80 per unit
Variable operating costs	$36 per unit
Fixed operating costs	$18000 per year

If production remained at 6000 units, the current selling price would be expected to continue throughout the remainder of the life of the product. However, if production is increased, it is expected that the selling price will fall to $72 per unit for all units sold. Again, this will last for the remainder of the life of the product.

No terminal value or machine scrap value is expected at the end of four years, when production of PD is planned to end. For investment appraisal purposes, Vernon uses a nominal (money) discount rate of 14% per year and a target return on capital employed of 22% per year. Ignore taxation

Required

Calculate the following values for the investment proposal.

Net Present Value;

Internal Rate of Return;

Return on Capital Employed (Accounting Rate of Return) based on initial investment; and

Discounted Payback Period

(14 Marks)

Explain briefly the key steps that should be included in a companys capital budgeting process.

(6 Marks)