SECTION A (QUESTION 1 IS COMPULSORY)
Firm "AAB" is considering investing in the production of a new product X. To this end
preliminary market research is undertaken that costs £400,000 in year 0. The
financial management of the firm expects that unit sales of the new product X will be
as follows: 75,000 units in year 1, 70,000 units in year 2, 120,000 units in year 3,
units in year 4, and 80,000 units in year 5. Production of the new product X
will require £1.5M (M=million) in net working capital (NWC) to start, which will be
completely recovered at the end of the 5 years. Total fixed costs are £800,000 per
le production costs are £300 per unit, and the units are priced at £400
each. The equipment needed to begin production has an installed cost of £25M and
can be depreciated by using the straight
line depreciation method. At the end of the 5
years, this equi
pment can be sold for 20 per cent of its acquisition cost. Firm "AAB" is
in the 35 per cent marginal tax bracket and has a cost of capital of 15 per cent.
Does the market research cost influence the project appraisal decision?
Calculate the Earnings
Before Interest and Taxes (EBIT) in each year, from year 1
to year 5.
Calculate the Net Cash Flow (NCF) in each year, from year 0 to year 5.
Calculate the Net Present Value (NPV) of the project at the discount rate of 15 per
cent. Should the
project be accepted according to the NPV method?
NPV = [NCF1/(1+r)+ NCF2/(1+r)^2+ NCF3/(1+r)^3...+ NCFn/(1+r)^n]-Initial Outlay... View the full answer