XYZ Ltd is considering whether to invest in a project which would entail immediate expenditure on capital equipment of Sh 40 million. Expected sales…

XYZ Ltd is considering whether to invest in a project which would entail immediate expenditure on capital equipment of Sh 40 million.

Expected sales from the project are as follows:

         Probability Sales Volume (units)

                   0.10   2,000,000

                   0.25   6,000,000

                   0.40   8,000,000

                   0.15  10,000,000

                   0.10  14,000,000

Once sales are established at certain volumes in the first year, they will continue at that same volume in subsequent years.  The unit sales price will be Sh10, the unit variable cost Sh 6 and additions fixed costs (except depreciation) Sh 20 million.

The project would have a life of 6 years, after which the equipment would be sold at Sh 4 million.  The company cost of capital is 10% and it is in the 40% tax bracket.

Required:

(a)    Compute the expected NPV.                                                                          (12 marks)

(b)    What is the minimum volume of sales per annum required to justify this project?                  (8 marks)

(c)    Is the project acceptable? Why or why not?                                                   (4 marks)

                                                                                                                       (Total: 24 marks)