Nutcracker has just developed a new product called WN1 and is now considering whether to put it
Question:
Nutcracker has just developed a new product called WN1 and is now considering whether to put it into production.
The following information is available:
The initial investment in machinery | $5 million |
Selling price (year 1 prices terms) | $100 per unit |
Variable production costs (year 1 prices terms) | $60 per unit |
Incremental fixed production costs (year 1 prices terms) | $1.5 million per year |
Expected demand | 80,000 units per year |
The investment project will have zero scrap value at the end of the fourth year. The incremental fixed production overheads noted above not include straight line depreciation on the machinery.
This investment will also require an investment in working capital of $500,000 payable at the start of the project. This is not expected to change during the life of the investment.
The selling price of each WN1 is expected to increase by 2% per annum.
Unless otherwise specified, all costs and revenues should be assumed to arise at the end of each year. The company’s after-tax cost of capital in money terms is expected to be 10%. It pays tax on profits at an annual rate of 20% per year.
Required:
1. Calculate the following for the proposed investment.
2. Net present value (NPV)
3. Internal rate of return (IRR)
4. Comment briefly on your findings in part (a) above and advice whether the investment proposal is financially acceptable.
Accounting Principles Part 3
ISBN: 978-1118306802
6th Canadian edition Volume 1
Authors: Jerry J. Weygandt, Donald E. Kieso, Paul D. Kimmel, Barbara Trenholm, Valerie Kinnear, Joan E. Barlow