Dundee Instruments has been approached to supply a modified form of one of its existing products on the basis of a fixed quantity and price contract. The initial reaction of the company’s management to the approach was very positive as the company is working below its capacity and is planning on making 20 members of its labour force redundant. the redundancies are implemented it would cost the company pound 240,000, but the contract would provide work for this group for the next five years and allow the company avoid these costs. The contract would be for 6,000 units per annum and a price of pound 400 per unit has been proposed by the company’s marketing director. The contract will require an investment in additional equipment and machinery of pound 1.2 million. This can be depreciated for tax purposes over a five year period, even though the contract will only run for four years. The capital equipment is expected to have a resale value of pound 0.4 million at the end of year four. The accommodation for the production will not pose any problems as the company has considerable spare capacity available. The cost of labour will be pound 800,000 per annum. materials will cost pound 180 per unit and the company will also incur fixed costs directly related to production of pound 140,000 per annum. The contract will also be allocated as a result of the company’s management accounting procedures a share of general overheads of pound 120,000 per annum and a charge for the use of floor space of pound 90,000 per annum. The company will hold stocks of raw materials, work in progress and finished products valued at pound 160,000. The company pays tax at 30 per cent and has a required rate of return of 14 per cent. Calculate the proposed investment’s net present value, stating all of your assumptions.Show transcribed image text Dundee Instruments has been approached to supply a modified form of one of its existing products on the basis of a fixed quantity and price contract. The initial reaction of the company’s management to the approach was very positive as the company is working below its capacity and is planning on making 20 members of its labour force redundant. the redundancies are implemented it would cost the company pound 240,000, but the contract would provide work for this group for the next five years and allow the company avoid these costs. The contract would be for 6,000 units per annum and a price of pound 400 per unit has been proposed by the company’s marketing director. The contract will require an investment in additional equipment and machinery of pound 1.2 million. This can be depreciated for tax purposes over a five year period, even though the contract will only run for four years. The capital equipment is expected to have a resale value of pound 0.4 million at the end of year four. The accommodation for the production will not pose any problems as the company has considerable spare capacity available. The cost of labour will be pound 800,000 per annum. materials will cost pound 180 per unit and the company will also incur fixed costs directly related to production of pound 140,000 per annum. The contract will also be allocated as a result of the company’s management accounting procedures a share of general overheads of pound 120,000 per annum and a charge for the use of floor space of pound 90,000 per annum. The company will hold stocks of raw materials, work in progress and finished products valued at pound 160,000. The company pays tax at 30 per cent and has a required rate of return of 14 per cent. Calculate the proposed investment’s net present value, stating all of your assumptions.
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