Question

1. Chemchiq Ltd. is considering the launch of a new product, Chems, for which an investment of Sh.6,000,000 in plant and machinery will be required. The production of Chems is expected to last five years after which the plant and machinery would be sold for Sh.1,500,000.

            Additional information:

1. Chems would be sold at Sh.600 per unit with a variable cost of Sh.240 per unit.
2. Fixed production costs (excluding depreciation) would amount to Sh.600,000 per annum.
3. The company applies the straight line method of depreciation.
4. The cost of capital is 10% per annum.
5. The units of Chems expected to be sold per annum for the next five years are shown below:

Year	Units expected to be sold
1	8,000
2	7,000
3	7,000
4	5,000
5	3,000

6. The corporation tax rate is 30%.

            Required:

1. Calculate the net present value (NPV) of the project and advise the management on the appropriate course action.                                                       (8 marks)
2. Calculate the internal rate of return (IRR) of the project and advise the management on the appropriate course of action.                          (4 marks)

Explain the decision criteria in case of conflict between NPV and IRR

Answer 1

Summary:

first we have to calculate initial investment of the project.

Next we have to calcuale cash flows of each for entire period of the project and then these cash flows should be discounted to present value using discount factors.

Then we can get Npv by deducting pv of cash flows from initial investment .

IRR is the rate at which pv of cash flows should be equal to initial investment.