The Adaptor Company has recently invested £40,000 in a market research survey to determine the demand for its new product, the AdaptAll. The bill for this survey has not yet been paid. Adaptor is encouraged by the survey and now has to decide whether or not to go ahead. The AdaptAll cost £50,000 to develop and if it goes ahead will need a further £10,000 spent on packaging development before it can be put on the market. The equipment needed to produce it will cost £180,000. The product will only have a four-year life. In years 1 and 2, annual sales will be 30,000 units, falling to 20,000 units in year 3 and 10,000 units in year 4. The selling price will be £12 per unit. The costs of producing the AdaptAll are as follows:

Materials – One unit of AdaptAll requires one unit of raw material. The company has 15,000 units of material in stock. This material originally cost £2 per unit but could be sold immediately for £3 per unit. The material could not be used by the Adaptor Company for any other of its products. If the AdaptAll project does not go ahead, the material will be sold. The current market price of the material is £4 per unit.

Labour costs are £2 for each AdaptAll.

Fixed overheads – The company will need to rent a new factory unit to produce the AdaptAll, at a cost of £50,000 per annum. It does not advertise its products individually but sends out a company catalogue every two months with details of all its products. The catalogue incorporates details of all existing and new products, including the AdaptAll. The catalogue costs £1,000,000 per annum to produce and distribute, and it is company policy to allocate an equal share of this cost to each of its products. AdaptAll will therefore bear its share, amounting to £10,000 a year. Variable overheads amount to £1 for each AdaptAll. At the end of the four years the machinery will be sold for £20,000. The company use  straight-line depreciation for all its assets. The company has a cost of capital of 10%, although projects are normally expected to achieve an IRR hurdle rate of at least 20%.

Tasks:
1.   Calculate the net present value (NPV) of the AdaptAll project.
2.   Estimate the effect on NPV of a reduction in sales volume of 10% per year, and use this to assess the % fall in volume that will reduce the NPV to zero.
3 Advise the company on whether or not it should proceed with the AdaptAll project, raising any other issues you feel should be considered in the decision. Your advice should incorporate comments on the use of the 20% hurdle rate as a decision rule.