PQP Company is a wholesaler of books that is keen to explore the financial implications of making a significant investment in equipment and the development of a website. Due to the fast-changing nature of the equipment and the Internet software, PQP’s management has set a project lifetime of four years, i.e., the equipment will be replaced, and a new website designed. An amount of N$300 000 will be paid for the new equipment at the beginning of the project. The company’s costs behave in such a way that its contribution to sales ratio is expected to be 40% and its net margin 10%.

Variable costs and the selling price are expected to remain stable in order to remain competitive over the duration of the project. Initial working capital of N$20 000 will be required at the start of the project. The suppliers will be paid a retaining/advisory fee of N$120.000 in year 1, NS150 000 in year 2 and N$170 000 and N$190 000 in years 3 and 4, respectively. The residual value at the end of the project will be N$30 000. PQP paid consultancy fees of N$150 000 to experts who worked on the equipment.

Additional information :

• PQP has a cost of capital of 14% and pays tax at an annual rate of 32%.
• It can claim capital allowances on a 25% reducing balance basis.
• Half of the tax is payable in the year it is incurred and half the following year and there has sufficient taxable profits from other parts of its business to enable the offset of any pre-tax losses on this project

REQUIRED

Use the Net Present Value (NPV) technique to evaluate whether PQP should go ahead with the project or not.