Northbank Ltd has developed a unique hedge trimmer. Market researchindicates that the demand for the trimmer at a unit selling price of £40 andadvertising cost over the next four years, are as follows:
Demand (units) Advertising cost (£)
Year 1 2000 10,000
2 4000 10,000
3 4000 5,000
4 1000 nil
The demand for the trimmer after Year 4 is expected to be too fewto continue marketing it. The variable cost per trimmer is expected to be £25.
The company expects to purchase a machine costing £120,000 atthe beginning of year 1 to manufacture the trimmer. The machine will be sold at the end ofYear 4 for £20,000. The straight line method for the calculation of depreciation will be used.
Assume no opening or closing stocks of the trimmer in each of thefour years. For Net Present Value (NPV) calculations, assume cash flows fromcosts and sales for a year take place at the end of that year.
The unit selling price and unit variable cost will remain unchangedduring the four years.
Payment for the purchase of the machine is expected to be made at the beginning of year 1.
Required
a) Determine for this project:
(i) The payback period.
(ii) The Accounting Rate of Return (ARR)
(iii) The net present value (NPV) at 10%.
(iv) The internal rate of return (IRR) using discount rates
of 10% and 12%.
b) Advise the company as to the profitability of this project.