QUESTION

MKV Plc is a manufacturing company based in Central Provincepart of Zambia. The company is evaluating an investment proposal tomanufacture special product called ‘HUA’, which has performed wellin test marketing trials conducted. MKV spent K20,000 on testmarketing trails.The following information relating to thisinvestment proposal has now been prepared.

Initialinvestment                                                      K2 million

Selling price (current priceterms)                           K20 per unit

Expected selling priceinflation                                3% per year

Variable operating costs (current priceterms)          K8 perunit

Fixed operating costs (current priceterms)            K170,000 per year

Expected operating costinflation                             4% per year

The demand forecast as a result of the test marketing trials areas follows:

Year                                       1                                 2                                 3                     4

Demand(units)                      60,000                        70,000                        120,000            45,000

It is expected that all units of ‘HUA’ produced will be sold, inline with the company’s policy of keeping no inventory of finishedgoods. No terminal value or machinery scrap value is expected atthe end of four years, when production of ‘HUA’ is planned to end.The minimum expected return by the investors from this investmentis 11% and a target return on capital employed of 32% per year. Thecompany target payback period is 2.1 years. Ignore taxation.

Required by showing all the workings and formulars:

a) Calculate the following values for the investmentproposal:

• Net Present Value;
• Internal Rate of Return;
• Accounting Rate of Return based on average investment;
• Payback Period.

b) Explain your findings in each section of (a) above and advisewhether the investment proposal isfinancially