Hungry Cake Creations is developing a new type of chocolate cake. Upfront investment in new plant...

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Hungry Cake Creations is developing a new type of chocolate cake. Upfront investment in new plant and machinery is required amounting to 1.5 million, with 1 million payable immediately and the balance payable at the end of the first year. An upfront/initial investment in working capital of 460,000 is also required, which will unwind in the year after production finishes. Hungry expects the plant to have a commercial life of 3 years. In the year after production finishes, the plant and equipment will be disposed of for 300,000. Hungry expects to sell 240,000 cakes per year at a current selling price of 25 and will be able to maintain a 20% contribution margin. Selling prices are expected to inflate by 5% per year after the first year of sales. Incremental fixed costs, which will not be subject to inflation, are expected to be 900,000 per year including depreciation. The depreciation policy of Hungry is to depreciate pant and machine on a straight line over the life of the asset. Tax is charged at 30% on profit before tax and is payable in the year after the year in which it is earned. Hungry uses a discount rate of 8% when assessing future projects. Required: QUESTION 4 a) Calculate the net present value of the project and advise Hungry Cake Creations on whether or not to invest in this new initiative. [16 marks] b) You have calculated the Internal Rate of Return (IRR) at 10.8%. Explain what information this gives you about the project and briefly explain what your recommendation would be if the project discount rate was to move to 12%. (You are not required to re-calculate the NPV). [3 marks] c) The senior management have several concerns about the reliability of the forecasts for this project. Identify and explain 2 ways in which the company could assess the project risk and explain how each method would incorporate risk into their decision-making process. [6 marks] Hungry Cake Creations is developing a new type of chocolate cake. Upfront investment in new plant and machinery is required amounting to 1.5 million, with 1 million payable immediately and the balance payable at the end of the first year. An upfront/initial investment in working capital of 460,000 is also required, which will unwind in the year after production finishes. Hungry expects the plant to have a commercial life of 3 years. In the year after production finishes, the plant and equipment will be disposed of for 300,000. Hungry expects to sell 240,000 cakes per year at a current selling price of 25 and will be able to maintain a 20% contribution margin. Selling prices are expected to inflate by 5% per year after the first year of sales. Incremental fixed costs, which will not be subject to inflation, are expected to be 900,000 per year including depreciation. The depreciation policy of Hungry is to depreciate pant and machine on a straight line over the life of the asset. Tax is charged at 30% on profit before tax and is payable in the year after the year in which it is earned. Hungry uses a discount rate of 8% when assessing future projects. Required: QUESTION 4 a) Calculate the net present value of the project and advise Hungry Cake Creations on whether or not to invest in this new initiative. [16 marks] b) You have calculated the Internal Rate of Return (IRR) at 10.8%. Explain what information this gives you about the project and briefly explain what your recommendation would be if the project discount rate was to move to 12%. (You are not required to re-calculate the NPV). [3 marks] c) The senior management have several concerns about the reliability of the forecasts for this project. Identify and explain 2 ways in which the company could assess the project risk and explain how each method would incorporate risk into their decision-making process. [6 marks]