Ring plc is evaluating the purchase of a machine to produce Product MP3, to which the following information applies:
.............................................................€ per box
Selling price...................................................11.00
Packaging and production...................................3.00
Components...................................................5.50
Incremental fixed costs will be €25,000 per year. The machine will cost €850,000 and will last for four years. At the end of four years it is expected to have a scrap value of €40,000. Additional initial investment in working capital of €80,000 will be required.
Annual sales of 150,000 units per year of Product MP3 are expected.
Ring plc has a nominal cost of capital of 10 per cent and a real cost of capital of 7 per cent.
Taxation may be ignored.
(a) Calculate the net present value of the proposed investment and the sensitivity of this net present value to changes in the following project variables:
(i) Selling price
(ii) Variable costs
(iii) Sales volume.
Comment on your findings. Ignore inflation in this part of the question.
(b) Further investigation reveals that the proposed investment will be subject to the following specific inflation rates:
(i) Selling price: 4 per cent
(ii) Variable costs: 4 per cent
(iii) Fixed costs: 5 per cent
(iv) Working capital: 4 per cent
Calculate the net present value of the proposed investment using a nominal (money) terms approach.
(c) Briefly discuss ways in which the evaluation in part (b) could be improved in order to support better decision-making.