amoose plc is a company based in the Teeside which manufactures components for the motorised scooter and bicycle industry. Vamoose’s Research and Development unit has recently developed an innovative new product for which there is considerable market demand. The production of this new product represents a major shift in Vamoose’s strategic direction as a company. Subsequently, the company is now planning to acquire a piece of equipment to manufacture the new product. The equipment will cost £6,600,000 and is expected to last for 5 years with an estimated scrap value of £2,300,000. Management expects to produce 160,000 units per annum (p.a.) of the new product, which will be sold for £68 per unit in the first year. Production costs per unit (at current prices) are as follows: Materials: £28.50 Labour: £24.40 Materials are expected to inflate at 8.5% p.a. and labour is expected to inflate at 6.5% p.a. Fixed overheads of the company currently amount to £1,370,000. These are not expected to increase as a direct result of manufacturing the new product. The company expects to be able to increase the selling price of the product by 9.5% p.a. An additional £760,000 of working capital will be required at the start of the project. Other data are as follows: Capital allowances: 20% reducing balance. Tax: 20%, payable immediately Cost of capital: 18% The NPV of the project is -£1,976,193.87 The IRR of the project is 7.39%. Project should not be accepted as NPV is negative and IRR is less than the cost of capital. Required: The production director at Vamoose has heard that the accounting rate of return and the residual income are appropriate methods to evaluate a project such as this. Critically compare these two approaches proposed by the production director.
Vamoose plc is a company based in the Teeside which manufactures components for the motorised
scooter and bicycle industry. Vamoose’s Research and Development unit has recently developed
an innovative new product for which there is considerable market demand. The production of this
new product represents a major shift in Vamoose’s strategic direction as a company. Subsequently,
the company is now planning to acquire a piece of equipment to manufacture the new product. The
equipment will cost £6,600,000 and is expected to last for 5 years with an estimated scrap value of
£2,300,000. Management expects to produce 160,000 units per annum (p.a.) of the new product,
which will be sold for £68 per unit in the first year. Production costs per unit (at current prices) are
as follows:
Materials: £28.50
Labour: £24.40
Materials are expected to inflate at 8.5% p.a. and labour is expected to inflate at 6.5% p.a. Fixed
overheads of the company currently amount to £1,370,000. These are not expected to increase as
a direct result of manufacturing the new product. The company expects to be able to increase the
selling price of the product by 9.5% p.a. An additional £760,000 of working capital will be required
at the start of the project. Other data are as follows:
Capital allowances: 20% reducing balance.
Tax: 20%, payable immediately
Cost of capital: 18%
The
The
Project should not be accepted as NPV is negative and IRR is less than the cost of capital.
Required:
The production director at Vamoose has heard that the accounting
income are appropriate methods to evaluate a project such as this. Critically compare these two
approaches proposed by the production director.
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