A company is considering the launch of a new 5G mobile phone. Experience from the sale of previous models has shown that the expected life of the new model is four years and life cycle sales will total 25,000,000 units. Sales volumes over the life cycle of the product will follow the pattern shown below.
Year 1 20%
Year 2 40%
Year 3 30%
Year 4 10%
The company’s research and development division, which has an annual budget of
N$$35,000,000, has developed a prototype of the 5G phone. A further investment ofN$600,000,000 in a new manufacturing facility will be required at the start of year 1 to put the new model into production. It is expected that the new manufacturing facility will have a residual value of N$100,000,000 at the end of four years.
The new model is to be marketed initially at a premium price of N$300 per unit. The price will remain at N$300 for the first year after which prices will be reduced by 20% per annum
The 5G model will be produced exclusively in the new manufacturing facility. The total fixed manufacturing costs will be N$300,000,000 per year excluding depreciation. It is also anticipated that a further N$150,000,000 will be spent in each of years 1 and 2 and N$100,000,000 in year 3, on further development and marketing of the new model. The variable cost per unit will be $125 and this is expected to remain the same throughout the life of the model.
It is estimated that the launch of the new model will result in a reduction in sales of the current 4G model of 2,000,000 units in the first year after which there will no longer be a market for the 4G model. It was never anticipated that there would be a market for the 4G model after this period. The contribution per unit of the 4G model is $100.
The company’s financial director has provided the following taxation information:
• Tax depreciation: 25% reducing balance per annum.
• Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises, the balance is paid in the following year.
• Any taxable losses resulting from this investment can be set against profits made by the company’s other business activities.
The company uses a post-tax cost of capital of 8% per annum to evaluate projects of this type. Ignore inflation.
(a) Calculate the net present value (NPV) of the project. Workings should be shown in $millions
(i) Calculate the internal rate of return (IRR) of the project.
(ii) Calculate the discounted payback period of the project.
(c) Discuss the reasons why a company may want to calculate the IRR and
discounted payback period of a project even though NPV is the
theoretically superior method of investment appraisal.
(d) Explain the benefits to a company of carrying out a post-completion audit
of a project
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