Delcom Ltd You are employed by Delcom Ltd, a company that manufactures and sells
ID: 421903 • Letter: D
Question
Delcom Ltd
You are employed by Delcom Ltd, a company that manufactures and sells a small range of precision engineered parts. Its customer base is the European car market.
Delcom is considering introducing a new product, E, for which the following capital expenditure, sales and cost estimates have been produced for its planned three year product life:
Year 0
Year 1
Year 2
Year 3
£'000
£'000
£'000
£'000
Capital expenditure
1,500
Other cash flows:
Sales income
700
800
1,000
Operating costs
200
250
300
The company’s cost of capital is 12%.
You have been provided with the following discount factors:
Year 0
Year 1
Year 2
Year 3
Discount factor at 12%
1.000
0.893
0.797
0.712
Requirements:
Calculate the Payback Period for the new product. (4 Marks)
Calculate the Net Present Value for the product. (4 Marks)
Recommend, on the basis of both the net present value and the payback period, whether the proposed new product E should be introduced. (2 Marks)
Year 0
Year 1
Year 2
Year 3
£'000
£'000
£'000
£'000
Capital expenditure
1,500
Other cash flows:
Sales income
700
800
1,000
Operating costs
200
250
300
Explanation / Answer
Capital Expenditure = 1500
Net Cashflow = (Sales Income - Operating costs)*discount factor
Net Cashflow at the end of Year 1 = (700-200)*0.893 = 446.5
Net Cashflow at the end of Year 2 = (800-250)*0.797 = 438.35
Net Cashflow at the end of Year 3 = (1000-300)*0.712 = 498.4
Net Cashflow after period of 3 years = 446.5+438.35+498.4 = 1383.25
So, Clearly the capital invested in the begining can't be recovered in the planned 3 years, as only 1383.25 is recovered out of 1500 according to the given parameters.
Payback Period of this new product E will be 3.xx years (between 3 & 4) - Ans 1
Now, the Net present value of the product = Net Cashflow after 3 years - Capital invested = 1383.25-1500 = -116.75 (Negative) - Ans 2
As the payback period is greater than the proposed product life of 3 years and the Net present value of the product is coming out to be negative, the new product E should not be introduced by Delcom Ltd. - Ans 3
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