Charm Plc, a software company, has developed a new game, ‘ Fingo’, which it plans to launch in the near future. Sales of the new game are expected to be very strong, following a favourable review by a popular PC magazine. Charm Plc has been informed that the review will give the game a ‘Best Buy’ recommendation. Sales volumes, production volumes and selling prices for ‘Fingo’ over its four-year life are expected to be as follows. Year 1 2 3 4 Sales and production (units) Selling price (LKR per game) 150,000 25 70,000 24 60,000 23 60,000 22 Financial information on ‘Fingo’ for the first year of production is as follows: LKR Direct material cost 5.40 per game Other variable production cost 6.00 per game Fixed costs 4.00 per game Advertising costs to stimulate demand are expected to be LKR 650,000 in the first year of production and LKR 100,000 in the second year of production. No advertising costs are expected in the third and forth years of production. Fixed costs represent incremental cash fixed production overheads. ‘Fingo’ will be produced on a new production machine costing LKR 800,000. Although this production machine is expected to have a useful life of up to ten years, government legislation allows Charm Plc to claim the capital cost of the machine against the manufacture of a single product. Capital allowances will therefore be claimed on a straight-line basis over four years. Charm Plc pays tax on profit at a rate of 30% per year and tax liabilities are settled in the year in which they arise. Charm Plc uses an after-tax discount rate of 10% when appraising new capital investments. Ignore inflation. Required: a) Calculate the new present value of the proposed investment and comment on your findings. b) Calculate the internal rate of return of the proposed investment and comment on your findings
Charm Plc, a software company, has developed a new game, ‘ Fingo’, which it plans to
launch in the near future. Sales of the new game are expected to be very strong, following a
favourable review by a popular PC magazine. Charm Plc has been informed that the review
will give the game a ‘Best Buy’ recommendation. Sales volumes, production volumes and
selling prices for ‘Fingo’ over its four-year life are expected to be as follows.
Year 1 2 3 4
Sales and production (units)
Selling price (LKR per game)
150,000
25
70,000
24
60,000
23
60,000
22
Financial information on ‘Fingo’ for the first year of production is as follows:
LKR
Direct material cost 5.40 per game
Other variable production cost 6.00 per game
Fixed costs 4.00 per game
Advertising costs to stimulate demand are expected to be LKR 650,000 in the first year of
production and LKR 100,000 in the second year of production. No advertising costs are
expected in the third and forth years of production. Fixed costs represent incremental cash
fixed production overheads. ‘Fingo’ will be produced on a new production machine costing
LKR 800,000. Although this production machine is expected to have a useful life of up to ten
years, government legislation allows Charm Plc to claim the capital cost of the machine
against the manufacture of a single product. Capital allowances will therefore be claimed on a
straight-line basis over four years.
Charm Plc pays tax on profit at a rate of 30% per year and tax liabilities are settled in the year
in which they arise. Charm Plc uses an after-tax discount rate of 10% when appraising new
capital investments. Ignore inflation.
Required:
a) Calculate the new present value of the proposed investment and comment on your
findings.
b) Calculate the
findings
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