Dinard plc has just developed a new product called "Rance" and is now considering whether or not it should start full-scale commercial production. The following information is available.
(i) Costs incurred in the development of Rance amount to Rs480,000.
(ii) Production of Rance will require the purchase of new machinery at a cost of Rs2,400,000 payable immediately. This machinery is specific to the production of Rance and will be obsolete and valueless when production ceases. The machinery has a production life of four years and a production capacity of 30,000 units per annum. The machine will be purchased at the start of year 1. Straight line capital allowances of Rs600,000 will be given each year starting in the year in which the machine was purchased.
(iii) Production coats of 1 unit of Rance (at year 1 prices) are estimated as follows:Variable materials Rs 8.00
Variable labourRs 12.00
Variable overheads Rs 12.00
In addition, fixed production costs (at year 1 prices), including straight line depreciation on plant and machinery, will amount to Rs800,000 per annum
(iv) The selling price of Rance will be Rs80.00 per unit (at year 1 prices). Demand is expected to be 25,000 units for the next four years.
(v) The Consumer Price Index is expected to increase at 5% per annum for the next four years and the selling price of Rance is expected to increase at the same rate. Annual Inflation rates for production costs are expected to be as follows:
Variable materials 4%
Variable labour10%
Variable overheads 4%
Fixed Costs 5%
(vi) Tax is levied at the rate of 35% and is payable in the year in which profit occurs
(vii) The project will not alter the business or financial risk of the company
(viii) The company is financed by debt and equity capital and the following information is availableEquity
Current share price Rs350
Number of shares in issue: 100,000
Dividend per share paid:
3 years agoRs23.60
A few days agoRs28.11
The past dividend growth is likely to continue for the foreseeable future. The stock market is informationally efficient.
Debt
(1) Bank loan of Rs12m at an interest rate of 12%
(2) 12% secured debentures redeemable at par in 5 years time. The current market price of the debentures is Rs940. The nominal value of the whole debenture issue is Rs8m.
(ix) Unless overwise stated, all costs and revenues should be assumed to occur at the end of each year.
Required:
Using the Net Present Value method, evaluate whether Dinard plc should start production of Rance.
All calculations are to be done to the NEAREST THOUSAND