Raindeer PLC is a highly profitable electronics company that manufactures a range of innovative products for industrial use. Its success is based to a large extent on the ability of the company’s development group to generate new ideas that result in commercially viable products. The latest of these products is just about to undergo some final tests and a decision has to be taken whether or not to proceed with an investment in the facilities required for manufacturing. You have been asked to undertake an evaluation of this investment. The company has already spent £750,000 on the development of this product. The final testing of the product will cost about £40,000. The head of the development group is very confident that the tests will be successful based on the work already undertaken. Another company has already offered Raindeer £1.10 million for the product’s patent and an exclusive right to its manufacture and sale, even though the final tests are still to be completed. This sum being offered is well in excess of the cost of the product’s development, but the company’s management have decided to delay their response to the offer until the result of the investment evaluation is available. The company anticipates that the product will remain competitive for the next five years after which it is likely to be displaced by some new product that are constantly being introduced as the underlying technology evolves. In the first year it is anticipated that 35,000 units will be sold at a price of £152. From year two through to year four sales are expected to be 45,000 units per annum, but are expected to fall back to 35,000 units in year five. The product will be manufactured in one of the company’s factories that has considerable spare capacity: it is most unlikely that the space required by the manufacture of this product will be required for any other purpose over the next five years. For the company’s internal accounting purposes all products are charged for the factory space that they utilise and this will amount to £50,000 per annum. The additional costs incurred by the company in the form of heating, lighting and power only amount to £30,000 per annum. a) Determine the investment’s net present value, the internal rate of return, payback period and the discounted payback period. All key assumptions should be specified and explained and an interpretation provided of results for each of the investment criteria specified. You should identify and explain the costs and benefits that you think should be included in a rational decision making process. On the basis of your analysis above, make a suitable recommendation for the company’s top management explaining the rationale behind it. (HINT : a good answer should clearly explain each figure used in the analysis – used or not). b) Assess how sensitive the calculated NPV is to three inputs employed in the analysis. Provide an interpretation of your results and comment on how valuable you think this analysis may be in taking a decision on the investment. Apart from the sensitivity analysis, use another one method (choose from scenario analysis, Monte Carlo simulation, BEP analysis) to assess your capital budgeting analysis and findings. Compare the methods used in reference to their risk probability.
Raindeer PLC is a highly profitable electronics company that manufactures a range of innovative
products for industrial use. Its success is based to a large extent on the ability of the company’s
development group to generate new ideas that result in commercially viable products. The latest
of these products is just about to undergo some final tests and a decision has to be taken whether
or not to proceed with an investment in the facilities required for manufacturing. You have been
asked to undertake an evaluation of this investment.
The company has already spent £750,000 on the development of this product. The final testing of
the product will cost about £40,000. The head of the development group is very confident that the
tests will be successful based on the work already undertaken. Another company has already
offered Raindeer £1.10 million for the product’s patent and an exclusive right to its manufacture
and sale, even though the final tests are still to be completed. This sum being offered is well in
excess of the cost of the product’s development, but the company’s management have decided to
delay their response to the offer until the result of the investment evaluation is available.
The company anticipates that the product will remain competitive for the next five years after
which it is likely to be displaced by some new product that are constantly being introduced as the
underlying technology evolves. In the first year it is anticipated that 35,000 units will be sold at a
price of £152. From year two through to year four sales are expected to be 45,000 units per
annum, but are expected to fall back to 35,000 units in year five.
The product will be manufactured in one of the company’s factories that has considerable spare
capacity: it is most unlikely that the space required by the manufacture of this product will be
required for any other purpose over the next five years. For the company’s internal accounting
purposes all products are charged for the factory space that they utilise and this will amount to
£50,000 per annum. The additional costs incurred by the company in the form of heating, lighting
and power only amount to £30,000 per annum.
a) Determine the investment’s
the discounted payback period. All key assumptions should be specified and explained and
an interpretation provided of results for each of the investment criteria specified. You should
identify and explain the costs and benefits that you think should be included in a rational
decision making process.
On the basis of your analysis above, make a suitable recommendation for the company’s top
management explaining the rationale behind it. (HINT : a good answer should clearly explain
each figure used in the analysis – used or not).
b) Assess how sensitive the calculated NPV is to three inputs employed in the analysis. Provide
an interpretation of your results and comment on how valuable you think this analysis may be
in taking a decision on the investment. Apart from the sensitivity analysis, use another one
method (choose from scenario analysis, Monte Carlo simulation, BEP analysis) to assess
your capital budgeting analysis and findings. Compare the methods used in reference to their
risk probability.
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