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Appraise the project using NPV approach

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Pine & Oak have spent ?20,000 researching the prospects for a new range of products. If it were decided that production is to go ahead an investment of ?240,000 in capital equipment will be required. The accounts department has produced budgeted profit and loss statements for each of the next five years for the project. At the end of Year 5 the capital equipment will be sold and production will cease.;The capital equipment is expected to be sold for scrap at the end of Year 5 for ?40,000.;Projected Profit/loss (in ?000s);Year 1 Year 2 Year 3 Year 4 Year 5;Sales 400 400 400 320 200;Materials 240 240 240 192 120;Other variable costs 40 40 40 32 20;Overheads 20 20 24 24 24;Depreciation 40 40 40 40 40;Net profit/(loss) 60 60 56 32 (4);When production start it will be necessary to raise material stock levels by ?30,000 and other working capital by ?20,000. Both the additional stock and other working capital increases will be released at the end of the project. Customers receive one year?s credit from the company. The overhead figures in the budgeted accounts have two elements ? 60% is due to a reallocation of existing overheads, 40% is directly incurred because of the take-up of the project. For the purposes of this appraisal, regard all receipts and payments as occurring at the end of the year to which they relate. The company?s cost of capital is 12%. Ignore inflation or tax.;Appraise the project using NPV approach. Should the company go ahead? Why or why not?

 

Paper#24192 | Written in 18-Jul-2015

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