Assessed Task 2: Evaluation of Proposed Investment in a Second Model

Your company’s Board of Directors is considering whether or not to launch a new artificially intelligent model of robot (‘Model 2’) in 2035 and you have been asked to:

  • evaluate the financial merits of this opportunity;
  • to make a recommendation to management regarding whether this investment decision should be implemented; and
  • to identify what other issues beyond your financial appraisal should be considered before a final decision is made.

The new model will require investment in R&D Project 11. If your business has not already invested in this project, the cost will be W$1.5m, of which 60% will be treated as Development costs and 40% as Research costs.

The new model will also require investment in a new R&D Project; either:

  • Project 20, which will cost W$300,000 if you have not already invested in R&D Project 11; or
  • Project 21, which will cost W$1.3m if you have already invested in R&D Project 11.

Again, 60% of the R&D cost will be treated as Development costs and 40%as Research costs.

The materials for this new model will cost W$3,000 per unit.

Following the results of a market research study which has already been carried out at a cost W$20,000, the marketing department has proposed that the retail sales price of the new model should be W$9,000 per unit (before retailer’s discount).

The market research suggests that at that sales price the sales volume for Model 2 for each year is expected to be as follows:

Year 1              200 units

Year 2              300 units

Year 3              400 units

Year 4              500 units

Year 5              600 units

Your company will need to carry out a technical feasibility study for the project at a cost of W$75,000.   If the investment does go ahead then the production of the new model will require the use of factory space which could otherwise be sub-let for annual income of W$30,000.

Also, it is estimated that the project will result in an increase in fixed overheads of W$25,000 per annum and an additional member of staff will need to be recruited to act as product manager for the new model.

Your company usually evaluates investment opportunities over a 5-year timescale using the Net Present Value method.

Your business has in the past applied the following assumptions when evaluating capital investment projects:

  1. an investment in working capital at the start of each year representing 5% of that year’s sales revenue will be required
  2. an allowance for general fixed costs of 10% of revenue be included in the analysis representing an allocation for general administration and overhead costs
  3. a cost of capital of 11% has been applied.

Task Details/Description:

Prepare a brief report for the Board of Directors which evaluates the financial merits of this investment opportunity.

Your report should address the following detailed requirements:

  1. Perform a financial evaluation of this investment opportunity. (A table highlighting the relevant cash flows together with detailed workings to support your net present value calculation should be presented in an appendix).
  2. Using the table below, explain your reasoning for the treatment of the items specifically referred to in the narrative above as ‘relevant cash flows’ or otherwise. (This table should be included in your main report and not in an appendix).
  Item Relevant Cash Flow? (Yes or No) Rationale for Treatment as Relevant or Otherwise
1 Cost of R & D Project 11 of $1.5m    
2 Cost of R&D Project 20 of $300,000    
3 Cost of R&D Project 21 of $1.3m    
4 Amortisation of R&D Project Costs    
5 Cost of market research study of $20,000    
6 Cost of technical feasibility study of $75,000    
7 Factory rental income of $30,000 per annum    
8 Increase in fixed overheads of $25,000 per annum    
9 Cost of additional staff member to act as Product Manager    
10 Allowance for general fixed costs of 10% of revenue per annum    

 

  1. Identify and briefly explain two non-financial considerations which you believe should be taken into account before a final decision is made.
  2. Provide a clear recommendation to the Board as to whether this project should go ahead.
  3. Provide a list of any assumptions you have made in an appendix.

Note: The majority of members of the Board of Directors do not have a finance background so your report will need to include clear and appropriate explanations of the financial techniques and concepts which you have used in your analysis.

Word limit: 500 words excluding tables, charts and appendices.