Solved: R plc plans to invest 1m in new machinery to

R plc plans to invest £1m in new machinery to produce Product GF. Advertising costs in the first
two years of production would be £70,000 per year and quality control costs would be 3 per cent
of sales revenue.

Sales revenue from Product GF would be £975,000 per year and production costs would be
£500,000 per year. Both sales revenue and production costs are at current prices and annual
inflation is expected to be as follows:

Sales revenue inflation...........................................4 per cent per year

Production cost inflation.........................................5 per cent per year

General inflation...................................................3 per cent per year

Initial investment in working capital of £80,000 will be made and this investment will rise in line
with general inflation. At the end of four years, production of Product GF will cease. Capital
allowances on the initial investment in machinery are available on a 25 per cent reducing
balance basis. The equipment used to make Product GF is expected to have a scrap value of
£50,000. R plc pays profit tax at a rate of 30 per cent per year and has a real weighted average
after-tax cost of capital of 8.7 per cent.

(a) Calculate the net present value of investing in the production of Product GF. Show all your
workings and explain clearly any assumptions you make.

(b) Calculate the sensitivity of the net present value of investing in the production of Product GF
to a change in selling price.

(c) Explain the difference between risk and uncertainty in relation to investment appraisal, and
discuss the usefulness of sensitivity analysis as a way of assessing the risk of investment
projects.

R plc plans to invest 1m in new machinery to

ANSWER
https://solvedquest.com/r-plc-plans-to-invest-1m-in-new-machinery-to/

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