Wayne Enterprises is looking to expand its business, by venturing into new sectors. They have designed a utility belt and have also commissioned a market research survey which suggests that a gap in the market exists. They aim to start with one design called the DKnight. This will require the purchase of a new machine. The data regarding this belt is shown below: The DKnight (per unit) £ £ Selling Price 20.00 Direct labour 8.00 Direct Material 2.00 Variable Overhead 2.20 12.20 7.80 It is estimated that Wayne Enterprises will sell 25,000 units per annum for the 4 year life of the project. At the end of year 4 the machine will be scrapped at zero value. The new machine will cost £300,000 and will have no residual value at the end of its four year life cycle. Depreciation is charged on a straight line basis. The market research cost of £20,000 is due to be paid in six weeks’ time. The fixed costs are £80,000 per year and it is estimated that 60% of the fixed costs are specific to the project. Unit labour costs will increase by 10% at the start of year 3 and by a further 10% at the start of year 4. Materials will rise by 10p per unit per annum from the beginning of year 2. Variable overhead unit costs are expected to remain unchanged throughout the life of the project. The company has a cost of capital of 14%. REQUIRED: (a) Prepare a schedule of cash flows for the project. (20%) (b) Evaluate the proposals by calculating the payback period and net present value. On the basis of your results, recommend whether the project should proceed. (15%) (c) There is a risk that sales will drop to 20,000 units from year two onwards due to the presence of rival brands entering the market. Recalculate the payback period and net present value if this were to happen. On the basis of your revised results, recommend whether the project should proceed. (15%) (d) “Payback is by far the most popular method of investment appraisal because it is the best method.” Discuss this statement. (20%) (e) Discuss what is meant by relevant costs and revenues in both short and long term decision making. (20%) Note: the final 10% of the grade will be allocated for presentation and referencing. (10%)
Solution ID:10086517 | Question answered on 16-Oct-2016
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