Finance and Financial Management

Question 1 (a)

Berick Ltd. is in the process of developing a high pressure valve which has a limited market. The product has completed the testing stage and now the company has to decide whether or not to invest in a production facility and a marketing programme. Preparation of capital budget for product production yielded following results-

The Net Present Value of investment is £3,801,482

Internal Rate of Return for investment is 25%

The above result tells us that it will be a profitable investment as the NPV of investment is high and the internal rate of return is greater than required rate of return which is 14%.

The key assumptions are as following-

* Tax and discount rates are constant across time

* At the start of each year stock equivalent to 25% of sales expected in year to come has to be held, this will make the working capital. The working capital is calculated using the selling price for the finished stock (£38 per unit). Assumption is made that the stock held is finished stock. If this stock was not held it could have been sold to increase the cash flow.

* Product will be in production for 6 years only

* Working capital will be fully closed out at the end of projects life.

* The taxable loss in year one can be written off against other projects within company

* The marketing cost of £150,000 and product development cost of 0.2 million will be incurred before the production starts for the product (before year 1).

* The only increase in overhead cost will be incremental cost resulting from heating and lighting which will be £10,000 (20% of 50,000). This is incremental cost as this cost would not have occurred without production taking place. It is assumed that the area of factory used for producing the new product would not have been lighted and heated in the absence of the production.

Question 1 (b)

Capital budgeting is a process of assessing the cash inflows and cash outflows from a prospective projects...