Coca-Cola company is planning to develop another product
line for its customers. Feasibility report shows that the
project will purchase the factory building at a total cost of
$300,000 which will be done in three instalments as follows
30% first instalments in year 1, 40% year 2 and 30% in year
3. The project will also purchase machinery at a total cost of
$120,000, spread over three years starting from year one as
follows $20,000, $50,000 and $50,000. The project will also
purchase two vehicles, one vehicle in year 1 and the second
vehicle in year 3 at a cost of $20,000 per vehicle.
The project would produce 1200 tonnes of output in year 3,
1800 tonnes in year 4 and 1950 tonnes in each year 5 to
year 8. Raw materials required for producing relevant
amount of coca cola per year will be equivalent to 40% of the
amount of output produced in that particular year. Sales of
coca cola output would be 75% of total production in year 3,
85% in year 4, 90% in year 5 and 100% in years 6 – 8. The
difference between production and sales would be sold on
credit to customer at an increment of 2% from the direct
selling price of outputs per year. The company will benefit
from selling other products/by-products which will be
produced in the same quantities as the coca cola outputs
per year but will be sold at $5,000 per tonne through out the
project life. The report suggests that for the project tooperate profitably, a unit tonne of coca cola output should
directly sell (on cash) at $8000. Raw materials will be
purchased at a cost equivalent to 30% of the selling price of
a tone of outputs directly sold for each year of production
It is also estimated that operating costs are $50,000 for
labour and $25,000 for utilities per year. In addition, the
project will incur maintenance cost of machinery as follows;
1% of total machinery costs in Years 3 & 4; 3% of total
machinery costs from Year 5 onwards. Maintenance cost for
vehicles will be 20% from the first year of purchase on ward.
Assume the discount rate is 12%.
REQUIRED:
1. On the basis of the above information draw up a
Resource Flow for the project. You may make any
assumptions you like on aspects not covered in the text
above, but you must make the nature of your
assumptions clear.
2. Analyse the proposed project using appropriate
investment selection criteria and techniques and make
a recommendation on whether or not the project should
be accepted.
To analyze the proposed project and make a recommendation on whether or not it should be accepted, we need to use appropriate investment selection criteria and techniques. One commonly used technique is the Net Present Value (NPV) method. Here's a step-by-step guide on how to perform the analysis:
Step 1: Prepare the Resource Flow for the project.
The Resource Flow will provide a clear overview of the inputs and outputs of the project. Based on the information provided, we can summarize the Resource Flow as follows:
Inputs:
1. Factory building: Total cost of $300,000, paid in three instalments over three years (30% in year 1, 40% in year 2, and 30% in year 3).
2. Machinery: Total cost of $120,000, paid in three years ($20,000 in year 1, $50,000 in year 2, and $50,000 in year 3).
3. Vehicles: Two vehicles at a cost of $20,000 each, purchased in year 1 and year 3.
Outputs:
1. Coca-Cola production: Varies by year (1200 tonnes in year 3, 1800 tonnes in year 4, and 1950 tonnes from year 5 to year 8).
2. By-products: Produced in the same quantities as Coca-Cola outputs, sold at $5,000 per tonne.
Other costs:
1. Raw materials: 40% of the amount of output produced in each respective year.
2. Operating costs: $50,000 for labor and $25,000 for utilities per year.
3. Maintenance costs: 1% of total machinery costs in years 3 & 4, and 3% from year 5 onwards. Maintenance cost for vehicles is 20% from year 1.
Step 2: Calculate the Cash Flows.
Based on the Resource Flow, we can calculate the cash flows for each year of the project. Cash inflows include sales revenue from Coca-Cola output and by-products, and cash outflows include the costs of inputs, raw materials, operating costs, and maintenance costs.
Step 3: Determine the Discount Rate.
The discount rate is given as 12%. This is the rate used to discount future cash flows to their present value.
Step 4: Calculate Net Cash Flows.
Net Cash Flows are calculated by subtracting the cash outflows from the cash inflows for each year, and then discounting them to their present value using the discount rate.
Step 5: Calculate the Net Present Value (NPV).
The NPV is calculated by summing up all the discounted net cash flows. A positive NPV indicates that the project is expected to generate a profit, while a negative NPV suggests that the project is not expected to be profitable.
Step 6: Evaluate the NPV.
Compare the NPV to an investment criterion. If the NPV is greater than zero, it suggests that the project will generate a positive return and should be accepted. If the NPV is less than zero, it indicates that the project is not expected to be profitable and should be rejected.
By following these steps and performing the necessary calculations, you can analyze the proposed project using the NPV method and make a recommendation on whether or not it should be accepted.