Auriga (Healthcare) has invested $220,000 over the past two years in the development of personal stress monitoring device (PSMD). The device is designed for busy individual wishing to check their stress levels Market research that was commissioned earlier in the year at a cost of $45,000 suggests that the price for the PSMD should be $22 per unit and that the expected product life cycle of the device is four years.
In order to produce the device, the business must immediately purchase specialist machinery and equipment at a cost of $300,000. This machinery and equipment has an expected life of four years and will have no residual value at the end of this period. The machinery and equipment can produce a maximum of 15,000 PSMDs per year over four years. To ensure that the maximum output is achieved, the business will spend $50,000 a year in advertising the device over the next four years.
Based on the maximum of 15,000 units per year, the PSMD has the following expected costs per unit (excluding the advertising costs above).
|
|
Notes
|
$
|
|
Materials
|
(1)
|
6.50
|
|
Labor
|
(2)
|
5.50
|
|
Overhead
|
(3)
|
8.50
|
|
|
|
20.50
|
Notes
1. The materials figure above includes a charge of $2 for a polymer that is currently in stock and can be used for this project. Each PSMD requires 200 grams of the polymer and the charge is based on the original cost of $1 per 100 grams for the polymer. It is a material that is currently used in other areas of the business and the cost of replacing the polymer is $1.50 per 100 grams. The polymer could easily be sold at a price of $1.25 per 100 grams.
2. The labor costs relate to payments made to employees that will be directly involved in producing the FSMD. These employees have no work at present and if the PSMD is not produced, they will be made redundant immediately at a cost of $230,000. If, however, the PSMD is produced, the employees are likely to be found other work at the end of the four-year period and so on redundancy costs will be incurred.
3. The figure indicates a depreciation charge for the new machinery and equipment. The policy of the business is to depreciate non-current assets in equal installment over their expected life. All other overheads included in the above figure are incurred in production of the new device.
4. Auriga uses a cost of capital of 10% to assess projects.
Ignore taxation.
Required:
Calculate the net present value of the project.