Please answer Part A

Fabric plc is considering a project to produce a new product line of fabric treated with silver ions which has been shown to reduce odour associated with bacteria in the fabric. The manufacturing process is significantly different to Fabrics more traditional fabrics and so will require investment in new equipment. Because this is new technology, the expected life of the project is only three years. The following information and estimates have been collated.

		Estimated specific inflation rates
Initial investment (new equipment)	212,000
Disposal value at the end of 3 years	20,000
Demand in metres of fabric per year	7,500
Selling price per metre	70	2%
Variable cost per metre	35	6%
Fixed production overheads per year	95,000	5%

• The tax rate is 30% paid one year in arrears. Capital allowances on equipment are claimed on a straight line basis over the life of the project.
• Fabrics CFO uses the real weighted average cost of capital as the discount rate. This is 8.57% and the general rate of inflation is 5%.

• a. Provide Fabric plc with a Net Present Value (NPV) analysis of the project and make a recommendation. The analysis should be in good form and show workings. Round to the nearest whole pound and percentage. Use discount factors to four decimal places. (17 marks)

• b. Write a report for Fabric plcs CFO that evaluates the use of the weighted average cost of capital to analyse the project and suggest a better alternative. (8 marks)

• c. The CEO of Fabric plc tells you that he finds it easier to understand IRR relative to NPV. Write a report to the CEO critically comparing NPV and IRR, and their relative merits and drawbacks. (10 marks)