Astro plc. is evaluating the purchase of a new machine to produce product V, which has a short product life cycle due to rapidly changing technology. The following information has been estimated by the financial manager: Initial investment: £1,000,000 Residual value: Nil Expected life: 5 Sales volume: 50,000 in year 1 and is expected to increase by 5% per year. Sales price: £22 per unit. Price is as med to be unchanged over the project life Variable cost: £10 per unit and expected to increase by 2% per year. Fixed costs: £320,000 per year. Cost of capital: 10%. Assume that Astro plc. has zero corporate tax rate and net profit on product V is equal cash. Required: (a) Based on NPV rule, should the project proceed? Show your workings. (b) Calculate the Internal Rate of Return (IRR) of the project. (c) Discuss the circumstances under which the weighted average cost of capital (WACC) can be used in investment appraisal. (d) Critically evaluate factors that the financial managers need to consider when applying NPV in practice.
Astro plc. is evaluating the purchase of a new machine to produce product V, which has a short product life cycle due to rapidly changing technology. The following information has been estimated by the
Initial investment: £1,000,000
Residual value: Nil
Expected life: 5
Sales volume: 50,000 in year 1 and is expected to increase by 5% per year.
Sales price: £22 per unit. Price is as med to be unchanged over the project life
Variable cost: £10 per unit and expected to increase by 2% per year. Fixed costs: £320,000 per year.
Cost of capital: 10%.
Assume that Astro plc. has zero corporate tax rate and net profit on product V is equal cash.
Required:
(a) Based on NPV rule, should the project proceed? Show your workings.
(b) Calculate the
(c) Discuss the circumstances under which the weighted average cost of
capital (WACC) can be used in investment appraisal.
(d) Critically evaluate factors that the financial managers need to consider
when applying NPV in practice.
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