Studland Ltd is considering the launch of a new product range, which it expects to achieve sales of 350 thousand units in each of the next five years, at a selling price of £28.00 per unit.

In order to manufacture the product, Studland will need to purchase new equipment at a cost of £8 million. The disposal value of this equipment after five years is estimated at £1.2 million.

The new product range will require an investment of £0.6 million in working capital at the start of the first year. No further investment in working capital is required, and this sum will be recovered in full at the end of the project.

The additional operating costs arising from the new range are estimated to be: £0.5 million per annum of fixed overheads; and £20.00 per unit of variable manufacturing and distribution costs.

The company uses a hurdle rate (discount rate) of 14% when evaluating capital expenditure proposals.

Apart from the initial investment, all cash-flows can be assumed to occur at the end of the relevant year. Ignore taxation.

Required:

1. Calculate the Net Present Value (NPV) and cash-flow payback of the project.

(20 Marks)

2. Recommend what action should be taken. Include in your answer an evaluation of the basis of your recommendation, and identification of any additional analysis you would wish to perform.

(10 Marks)

3. Compare and contrast the advantages and limitations of the NPV approach against that of other Capital Investment Appraisal techniques.

Answer rating: 100% (QA)

a SNo Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Total a Sales Price pu 2800 2800 2800 2800 2800 b Variable Cost pu 2000 2000 2000 2000 2000 c Con... View the full answer