Description
. (a) Prepare the case, with recommendations, to be presented to the Board of Directors of Genetik Plc. You
should assess the viability of the proposed project using the NPV, IRR and payback methods. (60 marks)
. (b) The IRR rule is redundant as an investment criterion because the net present value (NPV) rule always
dominates it. Discuss this statement giving examples where possible. (40 marks)
The word limit for answers to questions (a) and (b) is 2000 excluding tables and references.
As the newly appointed Chief Financial Officer of Genetik Plc, you are about to analyse a proposal for the
marketing and distribution of genetically engineered mustard seeds, which have been developed by a
biotechnology firm. This firm will supply seeds and permit Genetik to market and distribute them under a
licence.
Market research, costing 127,000, has already been carried out by Genetik to establish the likely demand for
genetically engineered mustard seeds. After five years, Genetik will stop selling these seeds as the company
anticipates that this product will be superseded by newer biotechnological developments.
The annual payment to the biotechnology firm will be 1,000,000 for the licence; this will be payable at the end
of each accounting year. 650,000 will be initially needed to buy a fleet of vehicles for distribution. These
vehicles will be sold at the end of the fifth year for 120,000. The project will require packaging and
administrative facilities. Genetik is a large firm and has a suitable factory with offices, currently lying unused.
The Head Office has stated that they will let this space to your project at a reduced rent of 550,000 per annum
payable at the end of each accounting year. However, the open market rental value is 900,000 per annum.
The project would start in 2017 and would not be subject to any taxation because of its special status as a growth
industry. A relatively junior and inexperienced accountant has prepared forecast of profit and loss accounts for
the project as shown in the following exhibit.
EXHIBIT TABLE
Year 2017 2018 2019 2020 2021
000 000 000 000 000
Sales 5480 6190 6890 9455 9900
Costs
Market Research 127
Raw Material 2320 3200 3410 3500 3500
Licence 1000 1000 1000 1000 1000
Vehicle Fleet Depreciation 130 130 130 130 130
Direct Wages 630 630 630 630 630
Rent 550 550 550 550 550
Overhead 750 750 750 750 750
Variable transport costs 625 625 625 625 625
Profit 652 695 205 2270 2715
By expanding its products range with these new mustard seeds, the firm expects to attract a great deal of
publicity which will improve the market position, and thus the profitability of its other products. The benefit is
estimated to be 47,000 for each of the five years.Head office normally allocates a proportion of its costs to any
new project as a part of its budgeting/costing process. This will be 50,000 per annum for this project and has
been included in the overheads calculated by the accountant. The remainder of the overheads is directly
related to the project.
The direct wages, seed purchases, overheads and variable transport costs can be assumed to be paid at the end of
each year. Sales revenues are also assumed to have been received at the end of each year. The project requires a
working capital of 1.5million which needs to be in place at the start of the project. This amount will be
recovered at the end of the project. Assume that there is no inflation. Given the riskiness of the project, a
discount rate of 11% is appropriate.
. (a) Prepare the case, with recommendations, to be presented to the Board of Directors of Genetik Plc. You
should assess the viability of the proposed project using the NPV, IRR and payback methods. (60 marks)
. (b) The IRR rule is redundant as an investment criterion because the net present value (NPV) rule always
dominates it. Discuss this statement giving examples where possible. (40 marks)
The word limit for answers to questions (a) and (b) is 2000 excluding tables and references.
As the newly appointed Chief Financial Officer of Genetik Plc, you are about to analyse a proposal for the
marketing and distribution of genetically engineered mustard seeds, which have been developed by a
biotechnology firm. This firm will supply seeds and permit Genetik to market and distribute them under a
licence.
Market research, costing 127,000, has already been carried out by Genetik to establish the likely demand for
genetically engineered mustard seeds. After five years, Genetik will stop selling these seeds as the company
anticipates that this product will be superseded by newer biotechnological developments.
The annual payment to the biotechnology firm will be 1,000,000 for the licence; this will be payable at the end
of each accounting year. 650,000 will be initially needed to buy a fleet of vehicles for distribution. These
vehicles will be sold at the end of the fifth year for 120,000. The project will require packaging and
administrative facilities. Genetik is a large firm and has a suitable factory with offices, currently lying unused.
The Head Office has stated that they will let this space to your project at a reduced rent of 550,000 per annum
payable at the end of each accounting year. However, the open market rental value is 900,000 per annum.
The project would start in 2017 and would not be subject to any taxation because of its special status as a growth
industry. A relatively junior and inexperienced accountant has prepared forecast of profit and loss accounts for
the project as shown in the following exhibit.
