(SOLVED) Next Technologies is a large computer company and is considering a new investment project. The company intend to develop a small computer designed to control home appliances.

Question

Next Technologies is a large computer company and is considering a new investment project. The company intend to develop a small computer designed to control home appliances. Once it is installed and programmed the computer will automatically control heating and air conditioning systems, security systems, hot water systems and others. By increasing the home energy efficiency the computer can cut costs enough to pay itself within a few year.

Right now the company is at the point of taking a decision on whether or not to go with full scale production.

The following information has been gathered

1) The vice president for marketing believes that annual sales would be 20,000 units each selling for 3000/= (60M). He does not expect any growth in sales units but the sales price will increase by 2% each year

2) Engineering department has reported that the project will require additional manufacturing space and the company has an option to purchase an existing building for this purpose at a cost of 12M.

• The building would be bought and paid for in December 2018 and would have 40 year life for purposes of depreciation which will be s 15% reducing balance.

• The necessary equipment would be purchased and in- stalled in late 2018 for 8M including transport and installation and would be paid for in on Dec 2018

• The equipment would have a five-year life and would be depreciated at 20% straight line basis

3) The projects estimated economic life is 4 years

4) At the end of the projects life the building is expected to have a market value of 5.5M and book value of 6.264M. Equipment on the other hand is expected to have a market value of 2M and book value of 1.6M

5) Production department estimates that the variable manufacturing costs will be 2100 per unit and fixed overheads costs excluding depreciation would be 8M a year.

6) The variable costs are expected to rise by 2% a year while fixed costs will rise by 1% per year

7) The marginal tax rate is 40% pa and the company's cost of capital is 12% pa Activate Windows Go to Settings to activate Windows.

8) For capita budgeting purposes the company's policy is to assume that operating cash flows occur at the end of each year. In this case the first flow would end of 2019

9) The company would invest 10% of sales revenue in net operating working capital (NOWC)

              Additional information

• Next Technologies is a relatively large company with sales of more than 4B and it takes on many investments each year.

• If the project is accepted the company will contractually be obligated to operate it for its full 4 years life as the management makes this commitment to its component suppliers

• Returns on this project would positively be correlated with the company's other projects and also with the stock market

• The project should do well if other parts of the firm are doing well and the general economy are strong

• Depreciation rates are allowed as deductions for tax purposes End of document Activate Windows Go to Settings to activate Windows.

                 Required

• Assume you have been assigned to conduct capital budgeting analysis on this project

• Assume that this project is in the same risk class as average project and use WACC of 12%

• Advise the management whether the project should be undertaken or not (use analytical tools ( NPV, IRR)

(20 Marks)