Aspiradora Limited Aspiradora Limited has an established market for its most well-known product, a popular traditional upright bagged vacuum cleaner called ‘Darkstar’. The company is now considering two alternative investment projects. The first proposal is to launch a modern bagless and cordless vacuum cleaner called ‘Supanova’ which has been developed in the company’s research lab. Supanova will be more expensive than the Darkstar model, but it is thought that its modern features will be attractive in a market where competition is constantly increasing. Because of the likelihood that sales will start to decline due to the advent of competition Aspiradora’s board has decided to evaluate this new project over a five-year time horizon. The cost of the new plant and machinery required for this project is estimated at £10 million, to be invested at the start of the project. The machinery is estimated to have a scrap value of £1.5 million at the prices expected to be prevailing at the end of 5 years. Aspiradora had commissioned market research at a cost of £90,000 for the Supanova project, half of which remains unpaid and is due for settlement. The market research report has estimated that 100,000 units of Supanova would be sold in the first year of the project. This sales volume would increase at about 4% per year for the next three years – but in the fifth year (the final year of the project) the sales volume is expected to dip by 5% due to the advent of new technology and the entry of competitors. At current prices, the company estimates that Supanova will command a selling price of £300 per unit. The material cost is estimated at 36% of the selling price, and the unskilled labour cost is estimated at 20% of the selling price. Fixed costs are not expected to increase significantly as a result of the new product. Each unit of Supanova will require one hour of skilled labour, which is in short supply. The company will have to transfer existing skilled labour away from manufacturing Darkstar, which requires half the skilled labour per unit that Supanova requires. The current selling price of Darkstar is £126, and the materials and unskilled labour costs for each unit of Darkstar add up to £104. These costs and revenues are at current prices. If the company decides to reduce the production of Darkstar, some of the older machinery could be sold one year from now, for a total value of £225,000 (at next year’s prices). By that time the written down value of this machinery for tax purposes would be £75,000. The company follows the accounting practice of depreciating its plant and machinery on a straight line basis over its useful life which, in this case, is estimated at 5 years. However, HMRC permits capital allowances to be claimed on new investment of this nature at the rate of 18% per annum, on a reducing balance basis. The company pays corporation tax at the rate of 19%, in the year in which it arises. © Vijay Lee Page 3 Since the new product is proposed to be manufactured in a vacant portion extending to about a quarter of the existing factory space, Aspiradora’s managing director proposes to allocate to the new project 25% of the annual rent of £160,000 being paid for the factory building. The directors also propose to allocate a total of £750,000 of the company’s existing overheads to the new project. One of the company’s marketing executives, who has been working with the managing director on the project, has ascertained that R&D expenses of £900,000 that were incurred over the last few years in developing the new bagless and cordless vacuum cleaner are yet to be written off – the executive has proposed that these costs should be taken into account for a correct project appraisal. For production and sales of ‘Supanova’ to reach the expected levels, the company would need to maintain an additional net working capital investment equivalent to 16% of the year’s sales. The required level of working capital investment would need to be in place at the start of each of the five years. All working capital investment would be recovered by the end of the fifth year. Using the information provided in the case, estimate the annual incremental cash flows of the proposed project for manufacture of the new Supanova vacuum cleaner. Provide clear reasoning for including or excluding any of the information that has been provided, politely explaining whatever errors you may observe in the opinions or proposals of the company’s directors and executives that are described in the above narrative.
Aspiradora Limited Aspiradora Limited has an established market for its most well-known product, a popular traditional upright bagged vacuum cleaner called ‘Darkstar’. The company is now considering two alternative investment projects.
The first proposal is to launch a modern bagless and cordless vacuum cleaner called ‘Supanova’ which has been developed in the company’s research lab. Supanova will be more expensive than the Darkstar model, but it is thought that its modern features will be attractive in a market where competition is constantly increasing. Because of the likelihood that sales will start to decline due to the advent of competition Aspiradora’s board has decided to evaluate this new project over a five-year time horizon. The cost of the new plant and machinery required for this project is estimated at £10 million, to be invested at the start of the project. The machinery is estimated to have a scrap value of £1.5 million at the prices expected to be prevailing at the end of 5 years. Aspiradora had commissioned
Using the information provided in the case, estimate the annual incremental cash flows of the proposed project for manufacture of the new Supanova vacuum cleaner. Provide clear reasoning for including or excluding any of the information that has been provided, politely explaining whatever errors you may observe in the opinions or proposals of the company’s directors and executives that are described in the above narrative.
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