Question

99m was paid the year before, for project to be installed

A computer manufacturer is considering making a new type of device called an iDevice (or iD). In the past year, the company spent £99m to develop the iD as payments to the inventor, Sliv Mobs. The machinery needed to make wl cost £200m and the device will be on sale for the product will be obsolete and the machinery will be sold for £35m. The machinery's costs (running costs, maintenance, depreciation) each year will be £61,25m per year four years. After that time it is believed that Budgeted revenues are estimated to be: Revenues (Em) 50 250 380 90 Year 4 If revenues exceed £100m in any year, then the inventor, Sliv Mobs, of the iD will be paid a royalty. This royalty will be 5% of annual revenues and will be paid one year after the year in which the revenues were made. The parts needed to make the iD will be bought from suppliers and will cost: Year Cost of Parts (£m) 10 50 80 18 Each year that the iD is sold, workers will be paid wages of £6m per year; however to meet demand, some extra workers will be employed in year 3, costing an extra £5m Starting from the first day of the production, before any sales is made, the company will advertise the iD. Each of four year next (forthcoming) year's budgeted revenue and payable in advance. The company's cost of capital is 10%. Assume all cash flows occur at the year end. unless otherwise indicated. s, the cost of advertising will equal 15% of the please see the following page for requirements) Required: conclude whether the con should proceed in its production ii) Calculate simple payback period (ii) Discuss what other factors you think the management should consider before deciding to make the iD

Answer 1

Cash flow calculations
Particulars	Year 0 (E m)	Year 1 (E m)	Year 2 (E m)	Year 3 (E m)	Year 4 (E m)
Revenues		50	250	380	90
Cost of machine and salvage value	-200				35
Royalty expense (5% of revenue)				-12.5	-19
Cost of parts		-10	-50	-80	-18
Wages		-6	-6	-6	-6
Additional wages				-5
Cost of advertising (15% of next year revenue)	-37.5	-57	-13.5
Net cash flows	-237.5	-23	180.5	276.5	82

Note: Running costs include depreciation, etc. The breakup is not given. Hence, the same has not been considered

99m incurred to develop the product are sunk costs and hence, irrelevant

1	NPV
	Particulars	Year 0 (E m)	Year 1 (E m)	Year 2 (E m)	Year 3 (E m)	Year 4 (E m)
	Cash flows	-237.5	-23	180.5	276.5	82
	Present value factor at 10%	1	1/(1.1^1)	1/(1.1^2)	1/(1.1^3)	1/(1.1^4)
	Present value factor	1	0.9091	0.8264	0.7513	0.6830
	Present value	-237.5000	-20.9091	149.1736	207.7385	56.0071
	Total present value of cash flows	154.5101

As the NPV is positive, the company can produce and sell the product iD

2	Payback period	Year 0 (E m)
	Initial investment	-237.5
	Cash flows in years
	Year 1 (E m)	-23
	Year 2 (E m)	180.5
	Year 3 (E m)	276.5
	Year 4 (E m)	82

By second year, the company generates 157.5 m. It requires to generate 80m more to recover initial investment of 237.5.

It generated 276.5 in 12 months. It implies that 80 is generated in (80/276.5)*12 = 3.4 months

Hence, payback period = 2 years and 3.4 months

3.

Along with financial feasibility, the company should also assess economic and technical feasibility.

The company should consider factors such as:

• Prospective customer study
• Market size and demand-supply gaps
• Market overview along with overseas market potential
• Sales process including intermediaries in supply chain
• Competitors and competitive forces study
• Demographic and behavioural factors
• Barriers to entry and exit
• Overall marketing and sales strategy
• Product standards, specifications and regulations related to it
• Preparation of construction sites
• Utilities availability
• Proposed technologies and alternative technologies
• Plant location and site access
• Production bottlenecks etc