Question

arks) (05 Marks) ks) b. Diamond Co has just developed a new product to be called Rubi and is now considering whether to put it into production. The following information is available. i. Costs incurred in the development of Rubi will amount to Rs.480,000 ks) ii. Production of Rubi will require the purchase of new machinery at a cost of Rs. 2,400,000 payable immediately. This machinery is specific to the production of Rubi and will be obsolete and valueless when that production ceases. The machinery has a production life of four years and a production capacity of 30,000 units per annum. iii. Production costs for one unit of Rubi (at year 1 prices) are estimated as follows. Rs. 8.00 12.00 Variable materials Variable labour Variable overheads 12.00 In addition, fixed production costs (at year 1 prices), including straight line depreciation on plant and machinery, will amount to Rs.800,000 per annum. Cnst relevant) iv. The selling price of Rubi will be Rs. 80 per unit (at year 1 prices). Demand is expected to be 25,000 units per annum for the next four years.

Is my answer correct?

Answer 1

See, your answer is not correct as you have taken discounting rate at 15%(nominal). we have to take discounting rate at 10%(real) which is after adjusting 5% inflation.

Also, you have not considered Fixed production costs. Out of total fixed production cost of 800000, 600,000 is depreciation. (2400000/4). Rest is variable part which is increasing at 5%. You have to consider that too.

So, the answer would be:-

Paticulars Units Rate Inflation YO Y 1 Y2 Y 3 Y 4 -2400000 Initial Cost Variable M Variable L Variable OH Fixed Production (other than dep) 25000 25000 25000 1 8 12 12 4 10 4 -200000 -208000 -300000 -330000 -300000-312000 -216320 -363000 -324480 -224973 -399300 -337459 200000 -200000 -210000 -220500 -231525 Sales 25000 80 2000000 2100000 2205000 2315250 Net flow Net flow (NPV) 1842693 946877.3 -2400000 1000000 1040000 1080700 1121993 -2400000 909090.9 859504.1 811945.9 766336.3

Yes, the project is viable as NPV is positive.