Investment Appraisal for Estia plc - The smart oven project Estia plc, is a large, established...

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Investment Appraisal for Estia plc - The smart oven project
Estia plc, is a large, established and fast-growing manufacturerof home appliances. The company is highly profitable and cash-richand has hired your management consulting company to advise theBoard on a new investment project. In the previous meeting of theBoard, the CEO has presented two alternative options for thedevelopment of a new smart oven. The new oven will function as anormal oven but will also allow the homeowner or user to havevirtual control remotely from the Web or via a mobile phoneapp.
The first option is for Estia plc to have the new ovenmanufactured in China and the second is to produce it at home, inits current UK manufacturing facilities.
The sales of the new smart oven are expected to be 100,000 unitsper year and the investment will last five years. At the end ofthis period, the investment will be terminated with no residualvalue. The selling and administrative costs will be £3,000,000 peryear.
The selling price of the new smart oven is estimated to be £360per unit.
Estia plc will have to make an initial investment of £20,000,000in non-current assets, at the start of the project. The full costof this investment in non-current assets will be depreciated over 5years, using the straight-line method.
We assume that the revenues and expenses occur at the end ofeach year. The corporate tax rate is 40%. All other taxes can beignored.
Estia plc will use 12% as the cost of capital for the newinvestment.
Option 1:
Estia plc decides to sub-contract the manufacturing of the smartoven to a Chinese manufacturer, paying the subcontractor anall-inclusive cost of £250 per unit.
Option 2:
Estia plc decides to manufacture the smart oven at its own homefactory. With this option, an initial investment in working capitalof £3,000,000 will be required, at the start of the project. Thisamount will be recovered at the end of the fifth year, when theinvestment will be terminated.
The production line will occupy plant space of 50,000 sq m,which otherwise could have been rented out for an annual rent of£2,800,000.
The cost of materials £140 per unit
Each unit will require 1 hour of engineer’s time and 2 hours ofskilled labour time.
The cost of labour for Estia plc is £40 per hour for the engineersand £20 per hour for the skilled labour workers.
Required:
a) Estimate the net present value and the internal rate ofreturn if Estia plc decides to sub-contract the production of thenew smart oven to a Chinese manufacturer (Option 1). Show clearlyyour workings.
b) Estimate the net present value and the internal rate ofreturn if Estia plc decides to
produce the new smart oven in-house (Option 2). Show clearlyyour workings.
c) Provide a short report for the Board of Estia plc discussingthe factors and issues that they have to consider in thedeliberation of their decision of which of the two options toapprove. You can include references to advantages, disadvantagesand risks of each option. As sensitivity analysis, estimate the NPVof the two options if the selling price increases by 10% ordecreases by 10%.
d) Produce a clear, well-structured and readable report.

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Investment Appraisal for Estia plc - The smart oven projectEstia plc, is a large, established and fast-growing manufacturerof home appliances. The company is highly profitable and cash-richand has hired your management consulting company to advise theBoard on a new investment project. In the previous meeting of theBoard, the CEO has presented two alternative options for thedevelopment of a new smart oven. The new oven will function as anormal oven but will also allow the homeowner or user to havevirtual control remotely from the Web or via a mobile phoneapp.The first option is for Estia plc to have the new ovenmanufactured in China and the second is to produce it at home, inits current UK manufacturing facilities.The sales of the new smart oven are expected to be 100,000 unitsper year and the investment will last five years. At the end ofthis period, the investment will be terminated with no residualvalue. The selling and administrative costs will be £3,000,000 peryear.The selling price of the new smart oven is estimated to be £360per unit.Estia plc will have to make an initial investment of £20,000,000in non-current assets, at the start of the project. The full costof this investment in non-current assets will be depreciated over 5years, using the straight-line method.We assume that the revenues and expenses occur at the end ofeach year. The corporate tax rate is 40%. All other taxes can beignored.Estia plc will use 12% as the cost of capital for the newinvestment.Option 1:Estia plc decides to sub-contract the manufacturing of the smartoven to a Chinese manufacturer, paying the subcontractor anall-inclusive cost of £250 per unit.Option 2:Estia plc decides to manufacture the smart oven at its own homefactory. With this option, an initial investment in working capitalof £3,000,000 will be required, at the start of the project. Thisamount will be recovered at the end of the fifth year, when theinvestment will be terminated.The production line will occupy plant space of 50,000 sq m,which otherwise could have been rented out for an annual rent of£2,800,000.The cost of materials £140 per unitEach unit will require 1 hour of engineer’s time and 2 hours ofskilled labour time.The cost of labour for Estia plc is £40 per hour for the engineersand £20 per hour for the skilled labour workers.Required:a) Estimate the net present value and the internal rate ofreturn if Estia plc decides to sub-contract the production of thenew smart oven to a Chinese manufacturer (Option 1). Show clearlyyour workings.b) Estimate the net present value and the internal rate ofreturn if Estia plc decides toproduce the new smart oven in-house (Option 2). Show clearlyyour workings.c) Provide a short report for the Board of Estia plc discussingthe factors and issues that they have to consider in thedeliberation of their decision of which of the two options toapprove. You can include references to advantages, disadvantagesand risks of each option. As sensitivity analysis, estimate the NPVof the two options if the selling price increases by 10% ordecreases by 10%.d) Produce a clear, well-structured and readable report.