- 20 Marks
FM – L2 – Q54 – Discounted Cash Flow
Calculate NPV for Kumasi Motors Ltd's new product line, considering capital expenditure, market share, and opportunity costs over four years.
Question
Kumasi Motors Ltd, a manufacturer of car accessories, is considering a new product line. This project would commence at the start of Kumasi Motors Ltd’s next financial year and run for four years. Kumasi Motors Ltd’s next year-end is 31st December 2005.
The following information relates to the project:
A feasibility study costing GH¢8 million was completed earlier this year but will not be paid for until March 20X6. The study indicated that the project was technically viable.
Capital expenditure
If Kumasi Motors Ltd proceeds with the project, it would need to buy new plant and machinery costing GH¢180 million to be paid for at the start of the project. It is estimated that the new plant and machinery would be sold for GH¢25 million at the end of the project.
If Kumasi Motors Ltd undertakes the project, it will sell an existing machine for cash at the start of the project for GH¢2 million. This machine had been scheduled for disposal at the end of 20X7 for GH¢1 million.
Market research
Industry consultants have supplied the following information:
Market size for the product is GH¢1,100 million in 20X5. The market is expected to grow by 2% per annum.
Market share projections should Kumasi Motors Ltd proceed with the project are as follows:
| 20X6 | 20X7 | 20X8 | 20X9 | |
|---|---|---|---|---|
| Market share | – | 0.07 | 0.09 | 0.15 |
Subcontractors
Some of the work on the project would be performed by subcontractors who would be paid the following amounts:
| Year | 20X6 | 20X7 | 20X8 | 20X9 |
|---|---|---|---|---|
| Payments to subcontractors (GH¢ million) | 10 | 12 | 15 | 15 |
Fixed overheads
Incremental fixed overheads (all cash expenses) will be GH¢5 million in each of the four years of the project.
Labour costs
At the start of the project, employees currently working in another department would be transferred to work on the new product line. These employees currently earn GH¢3.6 million. An employee currently earning GH¢2 million would be promoted to work on the new line at a salary of GH¢3 million per annum. A new employee would be recruited to fill the vacated position.
As a direct result of introducing the new product line, employees in another department currently earning GH¢4 million would have to be made redundant at the end of 20X6 and paid redundancy pay of GH¢6 million at the end of 20X7.
Material costs
The company holds a stock of Material X which cost GH¢6.4 million last year. There is no other use for this material. If it is not used, the company would have to dispose of it at a cost to the company of GH¢2 million in 20X6. This would occur early in 20X6.
Material Z is also in stock and will be used on the new line. It cost the company GH¢3.5 million some years ago. The company has no other use for it, but could sell it on the open market for GH¢3 million early in 20X6.
Further information
The year-end payables are paid in the following year.
The company’s cost of capital is a constant 10% per annum.
It can be assumed that operating cash flows occur at the year-end.
Time 0 is 1st January 20X6 (t1 is 31st December 20X6, etc.)
Required
Calculate the net present value of the proposed new product line (work to the nearest million).
Find Related Questions by Tags, levels, etc.
- Tags: Capital Expenditure, Cash Flows, Discounted cash flow, Inflation, Market share, NPV, Opportunity costs, Taxation
- Level: Level 2
- Topic: DCF: Specific Applications