Evaluation of Proposed Investment in a Second Model

Assessed Task 1: Evaluation of Proposed Investment in a Second Model

Your company’s Board of Directors is considering whether to launch a new recyclable model of robot in 2035 (‘Model 2’) and you have been asked to:

• evaluate the financial merits of this opportunity;
• to make a recommendation to management regarding whether this investment decision should be implemented; and
• to identify what other issues beyond your financial appraisal should be considered before a final decision is made.

The new model will require an investment in R&D of W$2m, all of which will be treated as Development costs.  To produce the new model, capital expenditure of W$600,000 and 5 extra production employees will also be required.

The materials for this new model will cost W$200 per unit less than those for non-recyclable robots.  

Following the results of a market research study which has already been carried out at a cost W$20,000, assuming your business maintains its retail sales price at the level set in 2034 there will be an increase in demand (compared with the level achieved in 2034) over the next five years as shown below:

Year 1 +200 units (compared with 2034)

Year 2 +250 units (compared with 2034)

Year 3 +300 units (compared with 2034)

Year 4 +350 units (compared with 2034)

Year 5 +400 units (compared with 2034)

Your company will need to carry out a technical feasibility study for the project at a cost of W$10,000.   If the investment does go ahead then the production of the new model will require the use of factory space which could otherwise be sub-let for annual income of W$25,000.  

Also, it is estimated that the project will result in an increase in fixed overheads of W$15,000 per annum.

Your company usually evaluates investment opportunities over a 5-year timescale using the Net Present Value method.  

Your business has in the past applied the following assumptions when evaluating capital investment projects:  

1. an allowance for general fixed costs of 8% of the extra revenue arising from the project be included in the analysis representing an allocation for general administration and overhead costs.
   
   
2. a cost of capital of 11% has been applied.

Task Details/Description:

Prepare a brief report for the Board of Directors which evaluates the financial merits of this investment opportunity.   Your report should address the following detailed requirements: 

1. Perform a financial evaluation of this investment opportunity.  (A table highlighting the relevant cash flows together with detailed workings to support your net present value calculation should be presented in an appendix).
   
   
2. Using the table below, explain your reasoning for the treatment of the items specifically referred to in the narrative above as ‘relevant cash flows’ or otherwise.  (This table should be included in your main report and not in an appendix).
   
   
3. Identify and briefly explain two non-financial considerations which you believe should be taken into account before a final decision is made.
   
   
4. Provide a clear recommendation to the Board as to whether this project should go ahead.
   
   
5. Provide a list of any assumptions you have made in an appendix.

Note: Most members of the Board of Directors do not have a finance background so your report will need to include clear and appropriate explanations of the financial techniques and concepts which you have used in your analysis.   You are not required to include an adjustment for working capital in your analysis.