How should I do my project?

How do i calculate the NPV of this project?

• Castle plc is a company that specialises in the design and production of a unique electronic device, referred to as TK7788 in the industry. TK7788 is used in most household appliances such as washing machines. Castle plc was set up by two brothers in 1995 and, in 2004, the company obtained a full listing on the London stock market. Over the last 6 years the company has embarked on a strategy of organic growth. To date, the company has managed to secure about 60% of the supply of TK7788 in the European market through their competitive tendering process. A major customer has informed Castle plc that his contract will not be renewed at the end of 2012. This customer accounts for 80% of Castle plc annual sales. Proposed Investment In view of losing a valuable customer and the current economic climate, the board of directors are assessing the possibility of diversifying into producing domestic security alarms for the UK market through a franchising arrangement. A ten year franchise from ABC corporation in the USA will cost £300,000. The equipment necessary for the assembly of alarm systems will cost £150,000. It is anticipated that the project will utilise land and facilities purchased by Castle plc three years ago for £200,000. A further improvement at cost of £100,000 was spent on the land and facilities last year. Research and other costs A research report commissioned from Monty Partners at a cost of £100,000 suggests Castle plc will be able to sell 2,000 units per annum for ten years at a unit cost of £400 each. An advertising campaign costing £100,000 will be required to support the estimated sales, starting the beginning of each year for the whole ten years of the project. The production manager has estimated the following costs: Materials £80 per unit Direct Labour £80 per unit Allocated Overheads £100 per unit There will be annual fixed costs of £80,000 per annum. The project will require an investment of £200,000 in working capital at the beginning of year one which will be recovered at the end of the project. Monty Partners have also estimated the scrap value of the land and production facilities at the end of the project to be £1,000,000. The financing for the project will be provided by a local bank at a cost of 15% per annum. The current market cost of the land and facilities to be used by this project is £650,000. Required: a) Estimate the Net Present Value for the above project showing all necessary calculation.

• Answer:

  You can not calculate a Net Present Value without knowing the Rate of inflation for the next 10 years (in fact you can't even calculate the profits from the product without making some assumptions on Material, Labor & Overhead prices over 10 years, plus, of course, what increase in the product sale price you can impose over 10 years ... Further, it is not stated if the financing cost (15% p.a.) is FIXED (if variable, how is it calculated ?) nor is it stated if the franchising cost has to be paid 100% 'up front' or if 'per year', is it 'annually in advance' or 'annually in arrears' .. By making some assumptions, you MAY be able to get some ball-park figures ... NB. another assumption might make is that the Bank loan can be 'drawn down' or 'repaid' as needed ... since (plainly) using the profits from the sale of the product to pay off a loan that's costing you 15% is likley to be the best possible use of any money coming in ... In fact, its entirely possible that sitting on the land and production facilities for 10 yaers and then selling at £1m will have a higher NPV than borrowing money and actually making anything .. PS If I was in this business, before scraping my existing product line I would take action to retain my major customer for the TK7788 - if necessary by suing my competitor for Patent infringement ..