Rigid Containment Solutions (RCS) produce a wide range of standard and custom bottles and carboys to cover
Question:
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 RCS’s 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:
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 RCS’s 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 RCS’s 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.
Financial Accounting An Integrated Statements Approach
ISBN: 978-0324312119
2nd Edition
Authors: Jonathan E. Duchac, James M. Reeve, Carl S. Warren