Reference no: EM133062176

Sam Malone Legend Limited (SMLL) is considering the introduction of a new product but it will be in competition with its existing products. The relevant details relating to the new product are as follows:

-The new product will have a life of 10 years.

-SMLL will require the purchase of new plant that will cost $1,500,000 which has a useful life longer than the products life cycle.

-The straight line depreciation (prime cost) for tax purposes is based on an effective life of 10 years; and the Company taxation rate is 30%.

-At the end of the project the plant has an estimated salvage value of $250,000.

-The projected Sales are $1,000,000 p.a. of the new project.

-The annual cost of goods sold (COGS) related to the project is $400,000; and an additional project supervisor will be required for the project's running at $100,000 p.a.

-SMLL will require Inventory to be purchased at the beginning of the year equal to $350,000 (which is not included in the COGS figure). This will be recovered & returned to initial levels, at the end of the project.

-SMLL will have to expand its operations and rent additional factory space (not included in COGS) of $50,000 p.a.

-The new product will cause a reduction in SMLL's existing products sales and the net lost sales are estimated to be $50,000 per year.

-Research & Development costs to date have run up to the amount of $350,000.

-The Required rate of return on projects the same as these for SMLL is 10%.

REQUIRED:

a) Calculate the cash flow at the start (year 0) of the project.

b) Calculate the cash flow over the life of the project (years 1-9).

c) Calculate the cash flow at the end (year 10) of the project.

d) Calculate the NPV of the project.

e) Advise SMLL whether or not the project should be accepted.

f) Calculate the internal rate of return (IRR) for the project and explain one limitation that can happen when only using IRR; as a primary decision making tool?