Brexit Medicine plc is considering buying some equipment to produce a medical drug named SHN. The new equipment's capital cost is estimated at £100 million. If its purchase is approved now, the drug can be bought and production can commence by the end of the year. £50 million has already been spent on research and development work. Estimates of revenues and costs arising from the operation of the drug are: Year 1 Year 2 Year 3 100 0.8 Year 4 Year 5 80 Sales price (£/litre) Sales volume (million litres) Variable cost (£/litre) Fixed cost (£m) 120 120 100 1 1.2 1 0.8 50 30 50 30 40 30 40 30 30 30 If the equipment is bought, sales of some existing products will be lost resulting in a loss of contribution of £15 million a year, over the life of the equipment. The accountant has informed you that the fixed cost includes depreciation of £20 million a year on the new equipment. It also includes an allocation of £10 million for fixed overheads. A separate study has indicated that if the new equipment were bought, additional overheads, excluding depreciation, arising from producing the drug would be £8 million a year. Production would require additional working capital of £30 million immediately, and from Year 2, this will increase each year by a further £5 million. For the purposes of your initial calculations, ignore taxation. Required: a. Calculate the relevant annual cash flows associated with buying the equipment.
Brexit Medicine plc is considering buying some equipment to produce a medical drug named SHN. The new equipment's capital cost is estimated at £100 million. If its purchase is approved now, the drug can be bought and production can commence by the end of the year. £50 million has already been spent on research and development work. Estimates of revenues and costs arising from the operation of the drug are: Year 1 Year 2 Year 3 100 0.8 Year 4 Year 5 80 Sales price (£/litre) Sales volume (million litres) Variable cost (£/litre) Fixed cost (£m) 120 120 100 1 1.2 1 0.8 50 30 50 30 40 30 40 30 30 30 If the equipment is bought, sales of some existing products will be lost resulting in a loss of contribution of £15 million a year, over the life of the equipment. The accountant has informed you that the fixed cost includes depreciation of £20 million a year on the new equipment. It also includes an allocation of £10 million for fixed overheads. A separate study has indicated that if the new equipment were bought, additional overheads, excluding depreciation, arising from producing the drug would be £8 million a year. Production would require additional working capital of £30 million immediately, and from Year 2, this will increase each year by a further £5 million. For the purposes of your initial calculations, ignore taxation. Required: a. Calculate the relevant annual cash flows associated with buying the equipment.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Transcribed Image Text:Brexit Medicine plc is considering buying some equipment to produce a medical drug
named SHN. The new equipment's capital cost is estimated at £100 million. If its
purchase is approved now, the drug can be bought and production can commence
by the end of the year. £50 million has already been spent on research and
development work. Estimates of revenues and costs arising from the operation of the
drug are:
Year 1
Year 2
Year 3
Year 4
Year 5
Sales price (£/litre)
Sales volume (million litres)
Variable cost (£/litre)
Fixed cost (£m)
100
120
120
100
80
0.8
1
1.2
1
0.8
50
50
40
30
40
30
30
30
30
30
If the equipment is bought, sales of some existing products will be lost resulting in a
loss of contribution of £15 million a year, over the life of the equipment.
The accountant has informed you that the fixed cost includes depreciation of £20
million a year on the new equipment. It also includes an allocation of £10 million for
fixed overheads. A separate study has indicated that if the new equipment were
bought, additional overheads, excluding depreciation, arising from producing the
drug would be £8 million a year. Production would require additional working capital
of £30 million immediately, and from Year 2, this will increase each year by a further
£5 million. For the purposes of your initial calculations, ignore taxation.
Required:
a. Calculate the relevant annual cash flows associated with buying the equipment.
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