A company is considering an investment of £1.4 million in a project that has a seven-year life. The company has estimated its discount rate at 12%. Details of the sales and costs arising from this project are as follows:
Sales volume: 250,000 units per annum
Sales price: £4 per unit
Costs
Direct materials (4 kg at £0.40 per kg) £1.60 per unit Direct labour (0.1 hour at £8 per hour) £0.80 per unit Overhead £330,000 per annum
Note that the annual overhead includes £200,000 per year depreciation on the asset. It also includes apportioned fixed overheads of a further £50,000 per year.
(a) Calculate the net present value of the project. Provide a commentary on the dis- counting process and on the net present value that you have calculated.
(b) Carry out a sensitivity anlaysis on five variables of this project, including the life of the project and the discount rate. Identify what you consider to be the most crit- ical variable and advise management what they should do, if anything, before adopting this project.