Plato Pharmaceuticals Ltd has invested £500,000 to date in developing a new type of insect repellent. The repellent is now ready for production and sale, and the marketing director estimates that the product will sell 150,000 bottles a year over the next five years. The selling price of the insect repellent will be £5 a bottle and variable costs are estimated to be £3 a bottle. Fixed costs (excluding depreciation) are expected to be £200,000 a year. This figure is made up of £160,000 additional fixed costs and £40,000 fixed costs relating to the existing business which will be apportioned to the new product.
In order to produce the repellent, machinery and equipment costing £520,000 will have to be purchased immediately. The estimated residual value of this machinery and equipment in five years’ time is £100,000. The business calculates depreciation on a straight-line basis.
The business has a cost of capital of 12 per cent. Ignore taxation.
(a) Calculate the net present value of the product.
(b) Undertake sensitivity analysis to show by how much the following factors would have to change before the product ceased to be worthwhile:
(i) the discount rate
(ii) the initial outlay on machinery and equipment
(iii) the net operating cash flows
(iv) the residual value of the machinery and equipment.