Ligon pic, a large electronics manufacturer, is considering a new project to manufacture a new type of
Question:
Ligon pic, a large electronics manufacturer, is considering a new project to manufacture a new type of battery (called the XTC) for use in electric cars. The project to manufacture and sell the XTC will last for four years.
The investment cost of the machinery needed to produce the XTC will be £7.25 million, and after four years of production its value will be zero. Depreciation allowances for tax purposes will be 25% of the origin cost in each year. The firm estimates that the sales of the XTC per year will be either 5000 units (probability 0.5) or 4000 units (probability 0.5), depending on whether its demand for the product is "high' or 'low The contribution per XTC (selling price minus variable production costs) will be £600.
The tax rate is 20% and tax is payable in the same year as taxable profit is made.
Assume that all cash flows occur at the end of the year except for those that occur now, and that the appropriate cost of capital for the project is 15%.
(a) Calculate the net present value (NP) of the 'high demand and the Tow demand' cases for the XTC project, assuming investment would occur immediately. What is the expected net present value of the project?
(b) Ligon can delay starting the project for one year to find out whether the level of demand for the XTC will be high' or 'low. Production and sales of the XTC would then take place for four years. If the firm chooses to delay, a competitor may enter the battery market now (probability 0.20) and Ligon's contribution per XTC would be reduced to £550 due to price competition.
What is the value now of the option to delay? Should Ligon undertake the project after exercising the delay option?
(c) Consider each of the following information:
(i) If Ligon delays the XTC project for one year, it could use the factory space for another short-term project that has an NPV of £30,000.
(ii) Ligon will finance the project by raising additional equity, now or in one year.
Examine whether or not each piece of information is relevant for the analysis of the HPC project (no calculations are needed for this part).
Expert Answer:
a To calculate the net present value NPV of the high demand and low demand cases for the XTC project we need to consider the cash flows for each year ... View the full answer
