Discuss any other factors you consider should be taken into account when making the final decision on whether to begin commercial production or not
Apex Ltd has just completed the development of a new personal alarm device. Development
costs totalled £50,000 and marketing costs to date total £5,000. A market survey suggests
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be sold each month.
The personal alarm market changes rapidly and the market survey indicated that the
probability of demand being maintained for:
2 years is 0.1
3 years is 0.5
4 years is 0.4
In order to start commercial production of the new device Apex Ltd must install a new
automated assembly line at a cost of £1.2 million. The assembly line can produce the
required quantity of the product but cannot be used for any other purpose and has nil disposal
value. Because nobody has used this type of assembly line before, its life expectancy
is uncertain. The best estimate available suggests that there is a 50 per cent chance that it
will last for 4 years and an equal chance that it will last for only 3 years.
The unit variable cost of the personal alarm is £20.00 and attributable fixed costs
totalling £100,000, excluding depreciation, will be incurred each year the personal alarm is
produced.
The cost of capital is 14 per cent per annum.
Requirements
(a) Calculate the expected net present value of going ahead with the production of the new personal alarm device.
(b) Advise the management on the viability of the project. You should:
(i) refer to your calculations in (a) above
(ii) include details of any assumptions made
(iii) discuss any other factors you consider should be taken into account when making the final decision on whether to begin commercial production or not.
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