Chapter 4 • Investment appraisal methods
Recently the business has developed a new TV set that has been named Flatview,
and a decision now needs to be taken as to whether to take it into production. The
following data are available:
1 If the decision is taken to go into production with the Flatview, production and sales
will start on 1 January 20X4 and end in 20X8. It is estimated that each set will be
sold for £2,000. It is also estimated that the annual production and sales of Flatview
televisions will be a steady 1,500 units for each of the five years.
2 Development and market research in relation to the Flatview were undertaken
during 20X3. The cost of these totalled £3 million. It is the business’s policy to write
off all such costs against profits as they are incurred. Of the £3 million, £1.8 million
was an apportionment of development department overheads. The remaining £1.2
million was spent on materials and services, including a market survey, which were
purchased specifically in respect of the Flatview project.
3 Assembly of the Flatview would take place in premises leased specifically for the
assembly work, separate from the business’s main premises. The directors believe
that suitable premises could be leased at an annual rent of £450,000, payable annu-
ally in advance.
4 Labour for the Flatview project is available from the business’s existing staff. If
the project is not undertaken the staff involved will be declared redundant on
31 December 20X3 and paid a total of £250,000 in compensation at that time. If the
project goes ahead the total incremental cost of employing the staff concerned is
estimated at £200,000 per annum throughout the duration of the project. At the end
of the project the staff concerned will all be made redundant, with estimated total
compensation cost of £300,000 payable at that point.
5 Assembly of each Flatview set requires the use of a number of different bought-in
components. Tenders have been obtained from the business’s normal suppliers,
and the lowest total purchase cost of all of the components necessary to make one
Flatview is £380. This figure includes £120 for component F451. This component is
the only one of which the business already has a stock since 500 units of F451 are
held in stock as the result of a surplus from a previous project. These originally cost
£80 each. If the Flatview project does not proceed, the only possible use for these
stock items has been identified as selling them back to the original manufacturer at
a price of £100 each, with the buyer bearing transport costs. Since the manufacturer
cannot use these items until the end of 20X5, delivery and payment will not take
place before that time. There are no incremental storage costs involved with retain-
ing this stock until 20X5.
Each Flatview set requires the use of one component F451.
6 Incremental overheads associated with the Flatview project are expected to cost
£200,000 for each year of production.
7 Plant and machinery will have to be bought and paid for on 1 January 20X4. The
total cost will be £5 million, which includes all installation costs. It is estimated that
at the end of the Flatview manufacturing project (20X8) the plant will have a disposal
value of £1 million.
8 The directors judge that the Flatview project will cost 15 per cent per annum to
finance.Prepare a schedule that derives the annual net relevant cash flows arising from the
Flatview project, and use this to assess the project on the basis of its net present value
as at 31 December 20X3.
Ignore any factors (such as taxation) that are not referred to in the question.