Your company, ABC Ltd, uses a 15% required rate of return to assess investments. You are proposing
Question:
Your company, ABC Ltd, uses a 15% required rate of return to assess investments. You are proposing to jump ahead of the opposition by installing a newly developed artificial intelligence production line which self learns from production errors. It is expected that this will cost $5,000,000 to fully install, including $250,000 of consultancy fees incurred to date, and it is expected to generate production cost savings of $2 per unit.
Production units have been forecast as:
Year 1 - 750,000 units
Year 2 - 650,000 units
Year 3 - 600,000 units
Year 4 - 500,000 unitsOther companies have expressed interest in the technology and it is forecast that at the end of year 4 the new production line will no longer be required by ABC Ltd, but can be resold for $2,000,000.
Discount Factors are:
Y1: 0.87
Y2: 0.76
Y3: 0.66
Y4: 0.57a) Calculate the Net Present Value (NPV) of the proposed project to install the new production line for ABC Ltd. (Assume all cash flows occur at the end of each year)
b) Calculate the simple payback period for the proposed project (Assume all production cashflows occur evenly during each year)
c) Given your NPV result, estimate, but do not calculate, the approximate IRR for the proposed project
d) How would you assess the potential impact of estimation risk in this project proposal? Describe and apply where relevant any quantitive approaches you could take to asses the sensitivity of estimation risk. Note that the required rate of return can be assumed to be constant at 15% at all times.
Cost Accounting A Managerial Emphasis
ISBN: 978-0133392883
6th Canadian edition
Authors: Horngren, Srikant Datar, George Foster, Madhav Rajan, Christ