Double Reliable Electricity
We are at the end of 2020. Double Reliable Electricity is a private company in Elbonia. It is considering a proposal to launch a new product, in addition
to its existing product lines. This new product will be based on a recent discovery made in 2019 (the company holds a patent) which will give Double
Reliable a two-year lead on its present competitors. The forecasts, established by the accounting department, are listed on the following Table 1 (please
refer to notes to the forecasts, below).
You must :
(a) Test the accuracy, and consistency, of the future cash-flows. Which entries make sense ? Which do not ? Why or why not ?
(b) Tell what additional information you would need to construct a version of Table 1 that makes sense ?
(c) Construct such a table (call it Table 1bis) and compute the NPV (VAN). Make all assumptions that are necessary.
(d) List the items / assumptions / numbers that would change the NPV (VAN). Please choose the most important items (assumptions / numbers), in your
opinion, and give an estimate of the various NPVs (VANs).
Notes to the forecasts (please refer to Table 1)
Capital expenditure (Investissements)
8 million $ represent the cost of the new machinery, and 2,4 millions $ stand for a warehouse extension (for new inventories, which will take half of the
space of the new warehouse). The new machinery will be set up in the current factory, where there is room available (no extension needed). All investments can be made by the end of 2019.
collection of payments. This has been estimated at 4 million $.
Sales for this project, in units sold are forecast as follows :
The price per unit is estimated to be fixed at 4 000 $ per unit. (Price remaining constant over the years).
Operating costs (coûts d'exploitation)
Direct and indirect operating costs represent 50% of the selling price.
Research and development
The patent comes from a successful research project, whose overall spending amounted to 1,94 million $ in 2019. This figure has been corrected for
3% inflation from the time of expenditure to date, that is 1,94 x (1+3%) = 2 million $.
Overhead costs (frais généraux et commerciaux)
Marketing and administrative costs for this project are estimated at 10% of sales.
Straight-line depreciation over 10 years.
Interest (intérêts sur dettes)
Financial expenses (interest on debt) generated by the financing of the project : capital expenditure + increase in operating working capital will be financed by a debt at a 5% interest rate.
Tax rate is 35%. Losses on the project are carried forward and deducted from taxable income in the following year.
Net Present Value (Valeur Actuelle Nette)
Operating Working Capital (Besoin en Fonds de Roulement)
This new production will require an additional investment in Operating Working Capital to purchase inventories, pay employees and wait for the