desperate assistance asap
Hi,
Just wondering if anyone could help me with this question, its for uni and I just cannot get my head around it, any help would be much appreciated!
A pharmaceutical company, is currently (at 1 January 2007) considering an investment in a new product, which is similar to the companys existing product range. The investment would involve the following costs and revenues:
(I) An immediate purchase of capital equipment costing /£ 2 million would be required. This equipment is expected to have a residual value in four years of /£ 200,000, and will be depreciated at 25% per annum on a straight line basis. Capital allowances can be claimed at 25% per annum on a reducing balance basis.
(ii) Sales of the new product will be /£ 2.5 million per annum for four years. Breakthrough Limited earns a contribution of 50% on sales.
(iii) The new product would require that a stores manager be recruited at a cost of /£ 60,000 per annum. However, there is an 80% probability that a manager who is due to retire would be interested in taking up the position, at an annual salary of /£ 40,000. If he retires, the company will have to make annual contributions of /£ 15,000 to fund his pension.
(iv) The new product will require an investment of /£ 361,000 in working capital. This should be assumed to arise on 1 January 2007.
(v) Annual fixed overheads relating to the new product are estimated at /£ 100,000, and in addition there will be allocated annual fixed overheads of /£ 40,000.
(vi) Research and development costs of /£ 200,000 have been incurred, and a further /£ 150,000 have been contracted for.
Requirement:
(a) Indicate whether Breakthrough Limited should proceed with the new product, using NPV.
(b) Compute the payback period.
(c) Calculate the accounting rate of return (after tax).
Assumptions:
You should assume a corporation tax rate of 12.5%. The tax liability is payable one year in arrears.
The applicable cost of finance (after tax) to be used for discounting is 11%.
