The project involves investment in a new machine to produce a recently developed product. The cost of the machinery, which is payable immediately, is £1.5 million, and the scrap value of the machinery at the end of four years is expected to be £100,000. Capital allowances (tax-allowable depreciation) can be claimed on this investment on a 25% reducing balance basis. Information on future returns from the investment has been forecast to be as follows:

 Year   1  2  3  4
 Sales Volume
 (units/ year)  50,000  95,000  140,000 75,000
 Selling Price
 (£/ unit)  25.00  24.00  23.00  23.00
 Variable Cost
 (£/ unit)  10.00  11.00  12.00  12.50
 Fixed Costs
 (£/ year)  105,000 115,000 125,000 125,000

This information must be adjusted to allow for selling price inflation of 4.0% per year and variable cost inflation of 2.5% per year. Fixed costs, which are wholly attributable to the project, have already been adjusted for inflation. Reuben plc pays profit tax of 30% per year one year in arrears.

Reuben plc has a nominal before-tax weighted average cost of capital of 12% and a nominal after-tax weighted average cost of capital of 7%.

 

Required:

(i) Calculate the Net Present Value (NPV) of the project and comment on whether it is financially acceptable to Reuben plc.

(ii) Calculate the Internal Rate of Return (IRR) of the project and comment on whether Reuben plc should proceed with it. (Try a discount rate of 52%).

Answer rating: 100% (QA)

SOLUTION i To calculate the NPV of the project we need to calculate the present value of the cash inflows and outflows associated with the project usi... View the full answer