Finance for Business: Castle Plc



Finance for Business: Castle plc

Background

Castle plc is a company that specialises in the design and production of a unique electronic device, referred to as TK7788 in the industry. TK7788 is used in most household appliances such as washing machines. Castle plc was set up by two brothers in 1995 and, in 2004; the company obtained a full listing on the London stock market.

Over the last 6 years the company has embarked on a strategy of organic growth. To date, the company has managed to secure about 60% of the supply of TK7788 in the European market through their competitive tendering process. A major customer has informed Castle plc that his contract will not be renewed at the end of 2012. This customer accounts for 80% of Castle plc annual sales.

Proposed Investment

In view of losing a valuable customer and the current economic climate, the board of directors are assessing the possibility of diversifying into producing domestic security alarms for the UK market through a franchising arrangement. A ten year franchise from ABC Corporation in the USA will cost £300,000. The equipment necessary for the assembly of alarm systems will cost £150,000. It is anticipated that the project will utilise land and facilities purchased by Castle plc three years ago for £200,000. A further improvement at cost of £100,000 was spent on the land and facilities last year.

Research and other costs

A research report commissioned from Monty Partners at a cost of £100,000 suggests Castle plc will be able to sell 2,000 units per annum for ten years at a unit cost of £400 each. An advertising campaign costing £100,000 will be required to support the estimated sales, starting the beginning of each year for the whole ten years of the project.

The production manager has estimated the following costs:

Materials £80 per unit

Direct Labour £80 per unit

Allocated Overheads £100 per unit

There will be annual fixed costs of £80,000 per annum. The project will require an investment of £200,000 in working capital at the beginning of year one which will be recovered at the end of the project. Monty Partners have also estimated the scrap value of the land and production facilities at the end of the project to be £1,000,000. The financing for the project will be provided by a local bank at a cost of 15% per annum. The current market cost of the land and facilities to be used by this project is £650,000.

Question

Estimate the Net Present Value for the above project showing all necessary calculation.

Initial Investment

Franchise Cost

£ 300,000

Alarm Systems Cost

£ 150,000

Working Capital Investment

£ 200,000

Land and Production Facilities

£ 300,000

Total Initial Investment

£ 950,000

Financing Required

£ 650,000

Interest Rate

15%

Annual Interest Expense

£ 97,500

Cost of goods sold for the project is as follows.

Materials £ 80

per unit

Direct Labour £ 80

per unit

Allocated Overheads £ 100

per unit

Total Variable Cost

£ 260

per unit

Fixed Cost

£ 80,000

A research report commissioned from Monty Partners at a cost of £100,000 ...