Reference no: EM133187221

Question - A company is considering whether to add a new product to its range. Machinery costing RM280,000 would have to be bought at the start of the project (Year 0). The project life would be five years with no disposal value at the end of the project. Sales of the new product are forecast at 12,000 units in each of Years 1 and 2, rising to 15,000 units in each of Years 3, 4 and 5. The selling price per unit will be RM15 in Year 1 and RM16 thereafter. Variable costs are estimated at RM9 per unit. Straight-line depreciation of the machine would be RM56,000 in each year. No other future incremental fixed costs would be incurred. However, the company has already incurred expenditure of RM6,000 for a market research survey and has decided to write this off against profits made in the first year if the investment takes place. Assume that all cash flows, apart from the investment in machinery, occur at the end of each year. The cost of capital is 14% per annum. Discount factors at 14% are:

Year 1 0·877

Year 2 0·769

Year 3 0·675

Year 4 0·592

Year 5 0·519

Required -

(a) Calculate the net cash flows for each year of the project (Year 0 to 5).

(b) Calculate the net present value of the project (working in RM000).

(c) State whether the internal rate of return is above or below 14% and justify your conclusion.

(d) Evaluate any THREE (3) advantages and THREE (3) disadvantages of payback method.