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QUESTION ONE

Bwembya has invented an electronic executive toy which can be activated to emit various noises on selection of one of six buttons. The toy is pocket-sized and it is anticipated that it will retail for K10. Bwembya is keen to exploit the toy and with the help of his business partner Bwalya, they consider the following possibilities.

• Sell the exclusive rights to the game to a major toy manufacturer for K110,000.
• Sell the rights to the manufacturer for K10,000 but receive an annual payment of K35,000 for the next five years (the payment being made at the end of each).
• Set up a manufacturing and selling operation. The best estimates for the next five years are:
• Initial capital expenditure: K30,000.
• Residual value at the end of year 5: K5,000.
• Net working capital required to start up: K10,000.

Year Sales (units) Sales price/unit Variablecosts/unit Fixed Costs p.a*

1 20,000 K10 K8 K45,000

2 40,000 K10 K8 K45,000

3 100,000 K10 K8 K45,000

4 60,000 K10 K8 K45,000

5 40,000 K10 K8 K45,000

*Note, Including depreciation of K5,000 p.a.

REQUIRED;

• Evaluate the proposals, given that the required rate of return is 20 per cent, and recommend the optimum proposal. Justify the reasons for your selection.
• What factors would influence your choice of a required rate of return?
• Would you advise the use of the cash payback method? Justify your answer with appropriate calculations

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