Question 2

Read through the information below and answer the questions that follow.

Rigid Containment Solutions (RCS) produce a wide range of standard and custom bottles and carboys to cover a wide range of applications, sizes, and connection systems. RCS is considering adding a range of Platinum rigid containers, designed specifically for the storage and transport of active, high-value pharmaceutical ingredients. The manufacturing process for Platinum containers is significantly different to RCSs more traditional containment products and 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:

RCS Platinum containers project data

		Estimated annual inflation rate
Initial investment in new machinery	440,000
Disposal value of machinery after 3 years	15,000
Annual demand for Platinum containers	8.250
Average selling price of Platinum containers	85	2%
Average unit variable production	40	6%
Fixed annual production overheads	115,000	5%

The corporate tax rate is 30% paid one year in arrears. Capital allowances are available on the initial investment in new equipment and are claimed on a straight-line basis over the life of the project. The CFO calculates RCSs real Weighted Average Cost of Capital (WACC) as 8.57%. The general rate of inflation is 5%.

a.Prepare a Discounted Cash Flow analysis of the project and calculate both the Net Present Value (NPV) and Internal Rate of Return (IRR).Make a clear recommendation as to whether RCS should proceed with the new project. Set out your analysis clearly and show all workings and assumptions you make in your analysis.Work to the nearest whole and percentage.But calculate compound interest factors and discount factors to four decimal places.

b.Write a report for RCSs CFO evaluating the use of WACC to evaluate the project and suggest a better alternative.

c.The CEO of RCS tells you that he finds it easier to understand IRR than NPV. Write a report to the CEO critically comparing NPV and IRR, and their relative merits and drawbacks.