Sico Co is evaluating the purchase of a new machine to produce product M, which has a short product life-cycle due to rapidly changing technology. The machine is expected to cost $3.5m. Production and sales of product M are forecast to be as follows:

Year |
0 |
1 |
2 |
3 |
4 |

Production and sales (units) | 30,000 | 45,000 | 82,000 | 40,000 |

The selling price of product M (in current price terms will be $30 per unit, while the variable cost of the product (in current price terms) will be $18 per unit. Selling price inflation is expected to be 5% per year and variable cost inflation is expected to be 3% per year. No increase in existing fixed costs is expected since Sico Co has spare capacity in both factory space and labor hour, however, Sico co has allocated fixed overhead of $10,000 pa to the project.

Producing and selling product M will call for increased investment in working capital. Analysis of historical levels of working capital within Sico Co indicates that at the start of each year, investment in working capital for product M will need to be 10% of sales revenue for the year.

Sico Co pays corporation tax of 28% per year in the year in which the taxable profits occur. Liability to tax is reduced by tax allowable depreciation on machinery, which Sico Co can claim on a straight line basis over the four-year life of the proposed investment. The new machine is expected to have no scrap value at the end of the four-year period.

Sico Co has a nominal cost of capital of 12% and a real cost of capital of 10%.

## Requirements:

Calculate the net present value of the proposed investment in product M. (12 marks)

Calculate the internal rate of the proposed investment in product M. (3 marks)

Advise on the acceptability of the proposed investment in product M and discuss the limitations of the evaluations you have carried out.

## Answers submitted

Created by | Ref | Marking | Action |
---|---|---|---|

b 10291 |
5 | ||

a 10102 |
15 | ||

b 10104 |
5 | ||

a 9890 |
14 / 15 | ||

b 9892 |
5 | ||

a 9748 |
15 | ||

b 9750 |
5 | ||

a 8892 |
15 | ||

b 8894 |
5 | ||

a 8406 |
15 | ||

a 8342 |
15 | ||

a 6278 |
15 | ||

a 2911 |
15 | ||

a 6276 |
15 | ||

b 7526 |
5 | ||

a 7010 |
15 | ||

b 7012 |
5 |

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