The research and development department of SAMARINA SA has produced two designs of product XYZ: model One and model Two. The development costs incurred, and already paid; in getting the models to design stage are €100,000 for model One and €120,000 for model Two. However, management has decided that the company has the facilities to support production and sales of only one of the two models in the foreseeable future.
For model One, it requires an investment in machinery with an estimated useful life of five years. The machinery will cost €3,000,000 and possess a disposal value of €200,000 if resold during the first three years of ownership, and €80,000 thereafter.
For model Two, the machinery would cost €2,200,000, have a useful economic life of five years and a disposable value of €150,000 at any time after initial installation.
The marketing department has estimated the annual demand for each model for the five years commencing 1 January 2013, which is the expected time period over which either model would be sold. The financial planning department has produced the following estimated annual operating cash flows:
|
Model One €000
|
Model Two €000
|
|
2013
|
420
|
800
|
|
2014
|
420
|
1,000
|
|
2015
|
1,000
|
450
|
|
2016
|
2,400
|
450
|
|
2017
|
1,200
|
450
|
It may be assumed that the annual operating cash flows will arise on the 31 of December in each year.
The company's money cost of capital is 12%.