Reference no: EM132937207

Healthcare Co. develops and manufactures sanitisation stations to help reduce the proliferation of viruses. Although it is committed to maximising the wealth of its shareholders, the company has incurred heavy losses over recent years. A new chief executive has now been appointed to turnaround the activities of the company. As part of the turnaround process, a review has been ordered of all projects involving new hearing equipment that were either still being developed or were already developed and about to be launched.

Recently, the company has developed a new equipment 'Rent-To-Kill' (RTC) and the directors of the company are now considering whether this equipment should be manufactured and sold.

The following information is available to help evaluate the viability of the new product:

(i) Costs incurred in designing and developing RTC, were $250,000. Half of this amount has already been paid and half is due immediately. These costs are to be written off in equal instalments against profits generated over the new product's expected life of four years.

(ii) Sales of RTC are expected to be 20,000 units over the 4 years. The selling price of each RTC unit will be $40 in the first three years and $30 in the final year.

(iii) Variable costs are estimated to be $16 for each RTC unit.

(iv) Additional fixed costs are expected to be $360,000 per year. This includes a charge for depreciation of equipment used in the manufacture of RTC of $90,000 per year.

(v) Equipment that originally cost $770,000 and which has a written down value of $470,000 will be used to produce the new product. If the new equipment is not manufactured, the equipment will be sold immediately for $410,000 as it cannot be used for any other purpose. If, however, the equipment is manufactured, the equipment will be sold at the end of four years for $70,000.

(vi) Additional working capital of $130,000 will be required immediately to support the manufacture of the new product. This will be released at the end of the life of the new product.

The company uses the net present value method and the discounted payback method to evaluate new investment opportunities. When applying these methods, the company uses a cost of capital of 10% and adopts a maximum discounted payback of two years.

Ignore taxation.

Required:

Problem (a) Calculate for the RTC project:

(i) the net present value

(ii) the discounted payback period

Problem (b) Critically evaluate two methods used to appraise investment projects