XYZ Ltd has spent £100,000 on research and development of a new product, expected to have a short economic life of two years only. The product development manager has recommended this production opportunity for consideration at the company's board. She believes that the new product perfectly fits the firm's strategic plan. The new product has already attracted the strong interest of a rival business, and if XYZ Ltd decides not to go ahead with production, it can sell the patent rights to the competitor for £160,000. The marketing manager has suggested that annual revenues will depend on whether the demand for the new product is weak or strong, forecasting the following levels of annual demand and the independent probability of each level of demand for the two years of the project's life: Year 1 Probability Year 2 Sales (units) 450,000 Sales (units) Probability 0.2 350,000 300,000 100,000 0.3 350,000 0.3 0.3 200,000 90,000 0.3 0.2 0.2 90,000 0.2 Manufacture of the new product will require the immediate purchase of a new equipment costing £450,000. The interest charges on the money borrowed to finance the equipment are expected to be £15,000 per annum. The equipment will have a residual value of £50,000 on completion of the project. Each unit of the new product can be sold for £6. The variable costs per unit of the new product are £2.5. The fixed costs incurred each year for factory upkeep and administrative expenses are £40,000. These fixed costs are unlikely to change as a result of the decision to expand the company's existing product range. XYZ Ltd has an opportunity cost of finance of 6 per cent per annum. Given the variability of future sales figures, the finance director believes that in order to enhance confidence in the decision advice to the company's board, the appraisal of the investment project should allow for risk. Required: |(a) Using the expected net present value rule, advise the company on the financial feasibility of the proposed project in respect of its expected life of two years. Ignore tax and inflation.

XYZ Ltd has spent £100,000 on research and development of a new product, expected to have a short economic life of two years only. The product development manager has recommended this production opportunity for consideration at the company's board. She believes that the new product perfectly fits the firm's strategic plan. The new product has already attracted the strong interest of a rival business, and if XYZ Ltd decides not to go ahead with production, it can sell the patent rights to the competitor for £160,000. The marketing manager has suggested that annual revenues will depend on whether the demand for the new product is weak or strong, forecasting the following levels of annual demand and the independent probability of each level of demand for the two years of the project's life: Year 1 Probability Year 2 Sales (units) 450,000 Sales (units) Probability 0.2 350,000 300,000 100,000 0.3 350,000 0.3 0.3 200,000 90,000 0.3 0.2 0.2 90,000 0.2 Manufacture of the new product will require the immediate purchase of a new equipment costing £450,000. The interest charges on the money borrowed to finance the equipment are expected to be £15,000 per annum. The equipment will have a residual value of £50,000 on completion of the project. Each unit of the new product can be sold for £6. The variable costs per unit of the new product are £2.5. The fixed costs incurred each year for factory upkeep and administrative expenses are £40,000. These fixed costs are unlikely to change as a result of the decision to expand the company's existing product range. XYZ Ltd has an opportunity cost of finance of 6 per cent per annum. Given the variability of future sales figures, the finance director believes that in order to enhance confidence in the decision advice to the company's board, the appraisal of the investment project should allow for risk. Required: |(a) Using the expected net present value rule, advise the company on the financial feasibility of the proposed project in respect of its expected life of two years. Ignore tax and inflation.

Essentials of Business Analytics (MindTap Course List)

2nd Edition

ISBN:9781305627734

Author:Jeffrey D. Camm, James J. Cochran, Michael J. Fry, Jeffrey W. Ohlmann, David R. Anderson

Publisher:Jeffrey D. Camm, James J. Cochran, Michael J. Fry, Jeffrey W. Ohlmann, David R. Anderson

Chapter5: Probability: An Introduction To Modeling Uncertainty

Section: Chapter Questions

Problem 18P: The J.R. Ryland Computer Company is considering a plant expansion to enable the company to begin...

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