Dolly plc is considering leasing a factory building for 4 years to produce a new product called GS7. The factory lease costs £100,000 annually and the £600,000 plant will be purchased upfront and depreciated over 4 years. Variable costs are estimated at £300 per unit (£200 labor, £100 materials). Administrative costs will increase by £90,000 annually during production. 400 units will be sold in year 1 for £1,400 each, increasing to 600 and 500 units in years 2 and 3, before decreasing to 200 units in year 4. The discount rate is 15% and the net cash flows will be used to calculate the net present value and internal rate of return of the project
Dolly plc is considering leasing a factory building for 4 years to produce a new product called GS7. The factory lease costs £100,000 annually and the £600,000 plant will be purchased upfront and depreciated over 4 years. Variable costs are estimated at £300 per unit (£200 labor, £100 materials). Administrative costs will increase by £90,000 annually during production. 400 units will be sold in year 1 for £1,400 each, increasing to 600 and 500 units in years 2 and 3, before decreasing to 200 units in year 4. The discount rate is 15% and the net cash flows will be used to calculate the net present value and internal rate of return of the project
Dolly plc is considering leasing a factory building for 4 years to produce a new product called GS7. The factory lease costs £100,000 annually and the £600,000 plant will be purchased upfront and depreciated over 4 years. Variable costs are estimated at £300 per unit (£200 labor, £100 materials). Administrative costs will increase by £90,000 annually during production. 400 units will be sold in year 1 for £1,400 each, increasing to 600 and 500 units in years 2 and 3, before decreasing to 200 units in year 4. The discount rate is 15% and the net cash flows will be used to calculate the net present value and internal rate of return of the project
Dolly plc is considering leasing a factory building for 4 years to produce a new product called GS7. The factory lease costs £100,000 annually and the £600,000 plant will be purchased upfront and depreciated over 4 years. Variable costs are estimated at £300 per unit (£200 labor, £100 materials). Administrative costs will increase by £90,000 annually during production. 400 units will be sold in year 1 for £1,400 each, increasing to 600 and 500 units in years 2 and 3, before decreasing to 200 units in year 4. The discount rate is 15% and the net cash flows will be used to calculate the net present value and internal rate of return of the project
The product development department of Dolly plc is contemplating renting a
factory building on a four-year lease from 1 January 20X1, investing in some new plant and using it to produce a new product, code named GS7.
Since there appears to be no possibility of the plant continuing to be economically
viable beyond a four-year life, it has been decided to assess the new product over a four-year manufacturing and sales life.
Under the lease the business will pay 100,000 annually in advance on 1 January.
The plant is expected to cost 600,000. This will be bought and paid for on 31 December 20X0 and is expected to be scrapped (zero proceeds) on 31 December 20X4. The business will depreciate this asset, in its accounts, on a straight-line basis (25% each year).
Each unit of GS7 is estimated to give rise to a variable labour cost of 200 and a variable material cost of 100. GS7 manufacture will be charged with an annual share of the businesss administrative costs, totalling 150,000 each year. Manufacture and sales of GS7s is expected to increase total administrative costs by 90,000 each year.
Manufacture and sales of GS7s are expected to be as follows:
Year ending 31 December
Year
Units of GS7
20X1
400
20X2
600
20X3
500
20X4
200
These will be sold for an estimated 1,400 each.
The businesss accounting year end is 31 December each year.
It has been decided, given the level of risk involved with the project to use a discount rate of 15% a year.
Required:
(a)
Identify the annual net relevant cash flows and use this information to assess the project on a net present value basis at 1 January 20X1.
(b)
Estimate the internal rate of return of the project.
