Question

QUESTION

MKV Plc is a manufacturing company based in Central Province part of Zambia. The company is evaluating an investment proposal to manufacture special product called ‘HUA’, which has performed well in test marketing trials conducted. MKV spent K20,000 on test marketing trails.The following information relating to this investment proposal has now been prepared.

Initial investment                                                       K2 million

Selling price (current price terms)                            K20 per unit

Expected selling price inflation                                 3% per year

Variable operating costs (current price terms)          K8 per unit

Fixed operating costs (current price terms)             K170,000 per year

Expected operating cost inflation                              4% per year

The demand forecast as a result of the test marketing trials are as follows:

Year                                        1                                  2                                  3                      4

Demand (units)                       60,000                         70,000                         120,000             45,000

It is expected that all units of ‘HUA’ produced will be sold, in line with the company’s policy of keeping no inventory of finished goods. No terminal value or machinery scrap value is expected at the end of four years, when production of ‘HUA’ is planned to end. The minimum expected return by the investors from this investment is 11% and a target return on capital employed of 32% per year. The company target payback period is 2.1 years. Ignore taxation.

Required:

a) Calculate the following values for the investment proposal:

• Net Present Value;
• Internal Rate of Return;
• Accounting Rate of Return based on average investment;
• Payback Period.

b) Explain your findings in each section of (a) above and advise whether the investment proposal is financially                        

Answer 1