) Identify the annual net relevant cash flows and use this information to assess the project on a net present value basis.
The product development department of Very Trusty plc is contemplating renting a factory building on a four-year lease from Year 1, investing in some new plant and using it to produce a new product, code named C15.
Since there appears to be no possibility of the plant continuing to be economically viable beyond a four-year life, it has been decided to assess the new product over a four-year manufacturing and sales life.
Under the lease the business will pay $100,000 annually in advance on 1 January.
The plant is expected to cost $600,000. This will be bought and paid for in Year 0 and is expected to be scrapped (zero proceeds) on 31 December Year 4. The business will depreciate this asset, in its accounts, on a straight-line basis (25 per cent each year).
Each unit of C15 is estimated to give rise to a variable labour cost of $200 and a variable material cost of $100. C15 manufacture will be charged with an annual share of the business’s administrative costs, totalling $150,000 each year. Manufacture and sales of C15s is expected to increase total administrative costs by $90,000 each year.
A market study conducted by an external consultant has provided the following expectations for the manufacture and sales of C15s:
Year ending 31 December Year Units of C15
1 400
2 600
3 500
4 200
These will be sold for an estimated $1,400 each.
The cost of market study was $5,500 and has already been paid.
The Business would have to invest $40,000 in
The business’s accounting year end is 31 December each year.
It has been decided, given the level of risk involved with the project to use a discount rate of 15 per cent a year.
Required:
(a) Identify the annual net relevant
(How to calculate the total cash flow ? & the
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