Beacon Chemicals plc is considering buying some equipment to produce a chemical named X14. The new equipment’s capital cost is estimated at £100 million. If its purchase is approved now, the equipment can be bought and production can commence by the end of this year. £50 million has already been spent on research and development work. Estimates of revenues and costs arising from the operation of the new equipment are:

Required:

(a) Deduce the relevant annual cash flows associated with buying the equipment.

(b) Deduce the payback period.

(c) Calculate the net present value using a discount rate of 8 per cent.

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Sales price (£/litre) Sales volume (million litres) Variable cost (£/litre) Fixed cost (£m) Year 1 100 0.8 50 30 Year 2 120 1.0 50 30 Year 3 120 1.2 40 30 Year 4 100 1.0 30 30 Year 5 80 0.8 40 30 If the equipment is bought, sales of some existing products will be lost resulting in a loss of contribution of £15 million a year, over the life of the equipment. The accountant has informed you that the fixed cost includes depreciation of £20 million a year on the new equipment. It also includes an allocation of £10 million for fixed overheads. A separate study has indicated that if the new equipment were bought, additional overheads, excluding depreciation, arising from producing the chemical would be £8 million a year. Production would require additional working capital of £30 million. For the purposes of your initial calculations ignore taxation.