Question

PLK Co is considering investing in new machinery as part of a launch of a new product, 'Quago'. The new machine is expected to have a useful life of four years and could be bought for GHS1,000,000, half of which would be paid immediately with the rest payable in a year's time. The scrap value of the machine after four years would be GHS30,000. The machine will be sold in the year following the end of the project.

Demand for the product in each of the four years is expected to be as follows:

Year 1 2 3 4
Production and sales (units/year) 35,000 53,000 75,000 36,000

The selling price of product P (in current price terms) will be GHS30 per unit. The variable cost of the product (in current price terms) will be GHS16 per unit. Selling price inflation is expected to be 3% per year and variable cost inflation is expected to be 5% per year. Fixed costs (in current price terms) relating to the project will be GHS10 per unit in the first year. The fixed cost is expected to remain unchanged throughout the project, and no inflation is expected.

Answer 1

PLK Co is evaluating a GHS1,000,000 investment in machinery over four years for a new product, taking into account the payment structure, scrap value, projected demand and sales, variable and fixed costs, and inflation. The financial viability of the project will involve analyzing adjusted revenue against costs, and ensuring positive cash flow and adequate return on investment.

Step-by-step explanation:

The presented scenario involves PLK Co, a company planning to invest in new machinery for a product launch (Quago). In analyzing whether to proceed, various financial aspects must be considered including the initial investment cost, the machine's useful life, scrap value, and projections for demand, selling price, and costs.

Initial investment for the machine is GHS1,000,000, with 50% paid upfront and the balance in one year. The projected scrap value is GHS30,000 at the end of the useful life of four years. The company expects to sell the machine following the project's end. Over the four years, the demand for Quago is anticipated to be 35,000 units in Year 1, 53,000 units in Year 2, 75,000 units in Year 3, and 36,000 units in Year 4.

The selling price is GHS30 per unit with a 3% anticipated annual inflation, whereas the variable cost is GHS16 per unit, with a 5% expected inflation per annum. Fixed costs are envisioned to be GHS10 per unit in the first year with no inflation adjustments in the subsequent years.

Analyzing these numbers helps determine the viability of the project by looking at metrics such as cash flows, net present value (NPV), and internal rate of return (IRR). Key considerations include whether the revenue from sales minus variable and fixed costs, with adjustments for inflations, results in a positive cash flow and if the potential earnings justify the investment.