- A Co Is A Leisure Company That Is Recovering From A Loss Making Venture Into Car Rental Three Years Ago The Company Pla 1 (69.69 KiB) Viewed 9 times
- A Co Is A Leisure Company That Is Recovering From A Loss Making Venture Into Car Rental Three Years Ago The Company Pla 2 (75.2 KiB) Viewed 9 times
A Co is a leisure company that is recovering from a loss-making venture into car rental three years ago. The company plans to launch two new products, A and B, at the start of July 2022, which it believes will each have a life-cycle of four years. A is the deluxe version of B. The sales mix is assumed to be constant. Expected sales volumes for the two products are as follows: Year A B 1 2 3 4 60,000 110,000 100,000 30,000 75,000 137,500 125,000 37,500 The selling price and direct material costs for each product in the first year will be as follows: Product Direct materials costs Selling price A Rs/unit 12 31 B Rs/unit 9 23 Incremental fixed production costs are expected to be Rs1 million in the first year of operation and are apportioned on the basis of sales value. Advertising costs will be Rs500,000 in the first year of operation and then Rs200,000 per year for the following two years. There are no incremental non-production fixed costs other than advertising costs. In order to produce the two products, investment of Rs1 million in premises, Rs1 million in machinery and Rs1 million in working capital will be needed, payable at the start of July 2022. Selling price per unit, direct material cost per unit and incremental fixed production costs are expected to increase after the first year of operation due to inflation:
Selling price inflation Direct materials cost inflation Fixed production cost inflation 3% per year per year 3% 5% per year These inflation rates are applied to the standard selling price and direct material cost data provided above. Working capital will be recovered at the end of the fourth year of operation, at which time production will cease and A Co expects to be able to recover Rs1.2 million from the sale of premises and machinery. All staff involved in the production and sale of A and B will be redeployed elsewhere in the company. A Co pays tax in the year in which the taxable profit occurs at an annual rate of 25%. Investment in machinery attracts a first-year capital allowance of 100%. A Co has sufficient profits to take the full benefit of this allowance in the first year. For the purpose of reporting accounting profit, A Co depreciates machinery on a straight-line basis over four years. A Co uses an after-tax money discount rate of 13% for investment appraisal. Discount factors at 13% are as follows: YR1-0.885, YR2-0.783, YR3-0.693 and YR4- 0.613 (a)Calculate the net present value of the proposed investment in products A and B as at 30 June 2022. (b)Identify and discuss any likely limitations in the evaluation of the proposed investment in A and B.