Economics Study question Assignment
Question 2 (25 marks)
Neqi plc has just invested in new equipment, costing £10.5 million, to manufacture a new type of reusable face mask. The firm conducted research for the mask to filter all variants of the COVID-19 virus. Further, the study suggested scope to sell an additional 500,000 units per year (from the current level). The new number of units will be the same from year to year. The research fee amounted to £0.45 million and will be paid in year 1 of the project. Each pack contains three masks.
The pricing structure (in British pounds) of the new mask is as follows:
Price per unit XX
Cost per unit output
Direct cost per unit 1.50
Fixed overhead cost per unit 1.00
The fixed overhead related to existing costs of the mask factory. The government granted Neqi plc a full tax rebate for the duration of the project due to higher quality of Neqi’s masks.
This article discussed the nature of face masks and a comparison of Neqi’s highly- regarded product and pricing against competitive products:
The new production line is expected to operate for four years. It required £0.5m of initial working capital which is expected to remain constant for the next four years. Working capital will be recovered at the end of the project life. The equipment will have a residual value of £2.0 million at the end of the life of the project.
The new production line is located in a presently empty building, purchased at £6.5 million three years ago, for which an offer of £1.5 million has recently been received from another firm. The building was retained and it is expected to be sold for £2.5m after 4 years.
Neqi’s strategic planning division made the following forecasts for the average annual rates of inflation relevant to the project:
Mask prices 5% p.a.
Direct costs 3% p.a.
Fixed overhead costs 5% p.a.
Neqi’s annual real cost of capital for projects of similar degree of risk is 8 percent. The general rate of inflation is 5.56 percent per annum.
a. What is the project’s actual / monetary cost of capital?
b. Provide the reasons for the irrelevance of three project cash flow items.
c. Assess the financial viability of the project using nominal/actual cash flows. Monetary figures should be in £’ million and intermediate computations should be in 2 decimal places.
Note: To show all workings with accompanying explanations.
Minimum number of references: 2.