Newlight Engineering is looking at the possibility of developing a new product called The Therm Controller. The demand for the product based on market research and a survey has been very positive. The survey indicates that the product could achieve a reasonable level of sales for 4 years. The survey which cost €50,000 has already been paid.

The initial capital outlay for new machinery to produce the Therm Controller will be €1,620,000. The machinery will have a useful life of 4 years and a nil scrap value at the end of year 4. If Newlight Engineering is to produce The Therm Controller, a training programme for staff will have to be put in place which will cost €100,000 and will be required prior to production commencing. An additional investment in working capital of €125,000 will be needed.

Sales and costs are estimated as follows:
Year 1 2 3 4
€000 €000 €000 €000
Sales 970 1,050 1,080 1,120
Cost of sales 550 510 505 480
Depreciation 405 405 405 405
Interest on Loan 24 24 24 24
Profit before Tax (9) 111 146 211

The employees that will be directly involved in producing the new product have no work at present and, if it is not produced, they will be made redundant immediately at a cost of €250,000. If, however, the device is produced, the employees are likely to find other work at the end of the four-year period and so no redundancy costs will be incurred.

NewLight Engineering has a cost of capital of 13%. All cash flows may be assumed to arise at year-end (except for the initial investment and working capital costs).

Actions required:

(a) Prepare a cashflow and calculate the Net Present Value for the new product (40%)

(b) Carry out a separate ‘what if’ sensitivity analysis to show by how much the following factors would impact the NPV of the project.

A 7% increase in the initial outlay on machinery (15 %)
A 7% increase in the cost of capital (round to the nearest whole number ( 15%)

(c) You have been employed as a consultant by Newlight Engineering to evaluate the viability of this new product. Write a report to the managing director outlining whether this capital investment should be considered by the company. Your report should clearly state the reasons for your decision, highlighting any further information that would be required before a final decision is made. The actions required in part (a) and (b) above should be shown as appendices/workings to this report (30 %)