Reference no: EM132532952
Green Chemicals Plc. has recently received an invitation to produce a new chemical for supply to a textile manufacturer. The invitation is to produce 15,000 kg each year for the next three years at a price of £42 a kg. The following information has been collected which will help the directors to reach a decision on whether to accept the invitation or not:
a) New plant costing £200,000 will need to be bought and paid for at the start of production. This will have a residual value of £10,000 at the end of the third year.
b) Ten new workers will be taken on for the duration of production. Recruitment costs, payable at the start of the production period will total £20,000. The workers will be paid compensation for being made redundant at the rate of £3,000 per worker, payable at the end of the production period. During the production period the workers will be paid £200,000 in total each year.
c) It is estimated that the production of the new chemical will give rise to an increase of £18,000 in overheads.
d) Production will require the use of an ingredient, known as X15G, at the rate of 6,000 kg each year. The business already has a stock of 4,000 kg. The cost of new X15G is £20 per kg.
X15G is used in large quantities on a number of the business's current products.
a) Production will also require the use of 9,000 kg each year of another ingredient, known as Y23D. The business already has 9,000 kg in stock. This was bought for a previous contract that had to be abandoned. If the stock of Y23D is not used in production of the new chemical there is no other use for it and it will be disposed of immediately. It will cost £2 per kg to dispose of the Y23D.Recently the buying price has dropped to £20 per kg.
b) Assessing the investment in the plant is to be undertaken on the basis of a finance cost of 11% each year.
Question 1) Justify which measure out of IRR and NPV is more robust for capital budgeting decisions.
Question 2) Explain the nature and treatment of sunk costs in capital budgeting decision making.
Question 3) Produce calculations which show, on the basis of net present value, whether the new chemical should be produced or not and state your conclusion.