Question 3Kako Ltd is considering introducing a new product unto the market. This will require the injection of capital to the tune of GH¢20,000 for the purchase of the equipment for production. The cost of the building that Kako Ltd intends to use for the project is GH¢30,000. The Production and Marketing department has presented the information in the table below: 2019Variable cost per unit of the productGH¢2Selling price per unitGH¢6Quantity4000 units per annumAgain the following information should be taken not of:Feasibility studies cost the company GH¢2000Test marketing expenses amounts to GH¢3000Variable cost will increase by 5% per annumSelling price will increase by 10% per annumMarketing expense will be 5% of sales revenue per yearAn initial working capital investment of GH¢2000 will be made. Subsequently, net working capital at the end of each year will be equal to 10 percent of sales for that year. In the final year of the project, net working capital will decline to zero as the project is wound down. In other words, the investment in working capital is to be completely recovered by the end of the project’s lifeAs a result of the introduction of the new product, sales of existing products will drop by 1000 units per annum. The selling price per unit of existing products is GH¢5 while the variable cost is GH¢ 4.Overhead cost will be fixed at GH¢6000 per yearThe project will last for five years (2019-2023) and the machines will be sold for a scrap value of GH¢2000Charge depreciation using the straight line methodCPC falls within the 25% tax bracketThe project cost of capital is 15%Required: Evaluate the project using NPV and advise the Management of Kako Ltd whether or not it should introduce the new product.

Assumption: Building is already purchased. So, cost of building is not a relevant cost for decision…

Answered: Kako Ltd is considering introducing a…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter9: Capital Budgeting And Cash Flow Analysis

Section: Chapter Questions

Problem 19P

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Question 3

Kako Ltd is considering introducing a new product unto the market. This will require the injection of capital to the tune of GH¢20,000 for the purchase of the equipment for production. The cost of the building that Kako Ltd intends to use for the project is GH¢30,000. The Production and Marketing department has presented the information in the table below:

	2019
Variable cost per unit of the product	GH¢2
Selling price per unit	GH¢6
Quantity	4000 units per annum

Again the following information should be taken not of:

Feasibility studies cost the company GH¢2000
Test marketing expenses amounts to GH¢3000
Variable cost will increase by 5% per annum
Selling price will increase by 10% per annum
Marketing expense will be 5% of sales revenue per year
An initial working capital investment of GH¢2000 will be made. Subsequently, net working capital at the end of each year will be equal to 10 percent of sales for that year. In the final year of the project, net working capital will decline to zero as the project is wound down. In other words, the investment in working capital is to be completely recovered by the end of the project’s life

As a result of the introduction of the new product, sales of existing products will drop by 1000 units per annum. The selling price per unit of existing products is GH¢5 while the variable cost is GH¢ 4.

Overhead cost will be fixed at GH¢6000 per year
The project will last for five years (2019-2023) and the machines will be sold for a scrap value of GH¢2000
Charge depreciation using the straight line method
CPC falls within the 25% tax bracket
The project cost of capital is 15%

Required:

Evaluate the project using NPV and advise the Management of Kako Ltd whether or not it should introduce the new product.

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