A company is trying to decide whether to make a £400,000 investment in a new product area. The project will last 10 years and the £400,000 of machinery will have a zero scrap value. Other best estimate forecasts are:
- Sales volume of 22,000 units per year;
- Sales price £21 per unit;
- Variable direct costs £ 16 per unit.
There are no other costs and inflation and tax are not relevant.
a. The senior management team have asked you to calculate the internal rate of return (IRR) of this project based on these estimates.
b. To gain a broader picture they also want you to recalculate IRR on the assumption that each of the following variables changes adversely by 5 per cent in turn:
- Sales volume;
- Sales price;
- Variable direct costs.