Reference no: EM132989380

Question - ABC ltd is a hypothetical producer of healthcare consumables. Currently, the company employs 20 workers at £30,000 per annum each. Predicting a continual demand for masks after the pandemic due to cultural and behavioural changes, the owner of the company intends to install a mask production line to produce high-grade air-filtering masks during the next four years. The cost of buying and installing such a production line is £200,000. The production line could be installed in the warehouse of 100m2 that the owner owns. The warehouse is currently unoccupied and could earn its owner £15,000 per annum in rent if let out on 01/01/2022. The cost of deep cleaning the warehouse and making the space suitable to install the production line and produce the high-grade masks is £100,000. The owner is told that the production line could be installed by the end of 2021 and ready for operation at the beginning of 2022.

The owner of the company would be happy to take up the insurance policy at a cost of £20,000 per annum to ensure the smooth running of the production line in addition to the standard maintenance expenses of £20,000 per annum. The owner does not expect any scrap value at the end of the fourth year.

The owner of the company plans to hire three workers at a cost of £30,000 per annum each to run the production line and employ a quality controller at a cost of £40,000 p.a. to ensure that the produced masks meet the UK quality standards. The workers must be trained at a cost of £1,000 each before they operate the machines in the mask production line. The production line under the three workers can produce 25,000 masks per day, which require £7000 worth of raw material. Expecting possible restrictions by the supply of the raw material, the company estimates that the production line could run for 200 days per annum. It is estimated that the electricity and water bill for this production line will be £10,000 per annum. The owner is confident that 95% of the masks they produce will meet the quality requirements. The masks could be sold in a box of 50 for £20 to healthcare suppliers.

Assume that:

-all items given above are at the prices of 2021 and the annual inflation rate applicable to all these items is predicted to be 2% in the life span of the project

-capital allowance rate (on the reducing balance scheme) is 25% per annum

-the current corporation tax rate is 28% and the tax is paid (or tax rebate is received) without any delay (that is, in the year when it accrues)

-the owner's expected rate of return on this investment is 15%.

Required -

Calculate the NPV of this project and recommend whether the company should accept or reject this project.

Explain why the owner's expected rate of return is as high as 15% when the interest rates are very low currently in the UK. Use information specific to this project to support your explanation.