UGB223 Business Finance|Produce

The produce development department of Braithwaite plc is contemplating renting a factory building on a five-year lease from 31 December 2010, investing in some new plant and using it to produce a new product, code named BB8. Since there appears to be no possibility of the plant continuing to be economically viable beyond a five-year life, it has been decided to assess the new product over a five-year manufacturing and sales life. Under the lease the business will pay £550,000 annually in advance on 31 December starting 31 December 2010. The plant is expected to cost £2,500,000. This will be bought and paid for on 31 December 2010 and is expected to be scrapped (zero proceeds) on 31 December 2015. The business will depreciate this asset, in the accounts, on a straight-line basis (20% each year). Each unit of BB8 is estimated to give rise to a variable labour cost of £375 and a variable material cost of £250. BB8 manufacture will be charged with an annual share of the business’s administrative costs, totalling £360,000 each year. Manufacture and sales of BB8’s is expected to increase total administrative costs by £240,000 each year. Manufacture and sales of BB8’s are expected as follows: Year ending 31 December Year Units of BB8 2011800 2012950 20131250 2014900 2015600 These will be sold for an estimated £4,500 each. 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 8% a year. Required:a.Identify the annual net relevant cash flows and use this information to assess the project on a net present value basis at 31 December 2010. (6 marks)b.Estimate and compute the internal rate of return of the project. (3marks)c.Briefly analyse the financial viability of investing in the project. (1 mark)d.Compare and contrast the differing methods that can be used to account for risk within the context of financial managers analyzing the viability of project investments
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