As part of my finance assessment, I have been asked to evaluate an
investment proposal relating to the manufacture of a new product. I'm
struggling with the answer and would like to see how an expert would
structure it.

The company?s Research and DevelopmentDepartment has been working on
this product for quite some time and has already spent £2.00m on its
development and it will be necessary to spend a further £400,000 to
complete the work. Management is confident that it will be able to
launch the product successfully
quite quickly without spending more than the planned amount.

The selling price for the product is expected to be set at £15.00 per
unit and it is anticipated that sales in the first year will be about
250,000 units, rising to 300,000 in year two, and sales are expected
to remain at this level for the following four years.  It is
anticipated that the product will no longer be competitive after six
years and it will be withdrawn from the market.

To manufacture the product an investment of £4.80 million will be
necessary in new production facilities. This expenditure can be
written off (capital allowances) for tax purposes on a straight-line
basis over the product?s six year life.  The re-sale value of the
equipment has been estimated to be about £0.50 million at the end of
the six years.  Use will also be made of some equipment the company
already owns.  This equipment is fully depreciated for tax purposes
but would be sold today for £0.60 million.  If used in the manufacture
of the product it is not expected to have any value at the end of the
six year period.  The production facility will be located in one of
the company?s factories that is not being fully utilised.  The company
has no alternative uses available for this space but it could be
rented out to another manufacturer who is short of space for £80,000
per annum.  The product will be charged £100,000 per annum for the
space it utilises through the company?s management accounting system. 
The fixed costs associated with the production are expected to be
£120,000 per annum. Each product sold by the company is also allocated
by the company?s accountant an overhead charge of 10 per cent of the
revenues it generates to cover head office expenses.  The direct
manufacturing costs are expected to be £3.50 per unit.  The company
will need to hold stocks of the product at the start of each year
equivalent in value to 20 per cent of the sales expected in the next
year.  The increase in debtors as a result of introducing the product
will be offset by the increase in creditors.  The company requires a
rate of return of 14 per cent on investments of this nature, and the
tax rate is 30 per cent.

a)	Determine the investment?s net present value, the internal rate of
return and payback period.  All key assumptions should be specified
and explained.
	
	
b)	Interpret the reported NPV, IRR and payback period.

Interesting question. Here are my answers

NPV= 342,000 $ (at hurdle rate of 14%)
IRR= 15.48%
payback period= 4 yrs

Main assumptions

1. All expenses are tax deductible
2. Tax is deductible on all expenses incurred in a year (this may not
be real given tax authorities allow deduction of expenses only related
to sales in a given year (we are producing 20% extra))
3. I was not clear about a 80,000 and 100,000 per annum expense. Are
these for the same thing or not. I have assumed both these expenses to
be payable.
4. The following were take as one time investments R&D-2.4m, Prod-
4.8M, Free faclity -0.6M. Salvage value for all this was 0.5M

I find this interesting. Would be happy to discuss further. Feel free
to contact me directly as well.

forgot to interpret it..here is my take

Since the IRR is higher than 14% and NPV positive the project creates
value for the company.

However, before going in for the project the company should make sure
that it has no other avenue of investing this money which can generate
higher IRR than this investment.