Managerial Accounting

NuriaCollezione is a fashion clothing company. Nuria, the chief executive, regularly attends major fashion events in order to spot trends in the market. She has recently returned from a show that featured fake fur waistcoats and she thinks these could be next season’s big fashion story. Unfortunately, fake fur tends to clog up the production machinery used in the company’s factory, and it will be necessary to make an additional investment of €28 000 in new cutting and sewing machinery. Nuria thinks it is quite likely that sales of 6000 waistcoats are achievable in the first year, and possibly up to 2000 in the second year. Her knowledge of fashion trends tells her that after that point the waistcoats will probably be unsaleable except at very heavy discounts. The first 5000 waistcoats will almost certainly sell at full price, and should produce a net cash flow of €4 each. The final 3000 of production may have to be sold at a discount and it is safest to assume that net cash flow will be only €3 per waistcoat. The machinery will be saleable at the end of the second year for around €10 000.

i) Assuming that the company’s cost of capital is 13%, what is the NPV of the project?

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ii) If Nuria’s initial projections were wrong, and only 5000 of the waistcoats could be sold, all in the first year and producing net cash flow of €4 each, what would be the NPV of the project? Assume in this case that the machinery is saleable at the end of the first year for €13 000.

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