Financial Viability Of Ecovan Project Report
DL Tourers ltd is one of the market leaders in the UK for the manufacture of touring caravans. Being
aware of the environmental impact of towing a caravan and also of the move to make cars with a
smaller engine and/or battery power to reduce the carbon impact of vehicles it has spent £1,200,000
developing a new caravan, code named Ecovan, which is much lighter than existing models and is also
more aerodynamic to reduce drag. It has now reached a stage where a decision whether to proceed or
not with the promotion and production of the new model must be taken. It is keen to proceed quickly as
DL Tourers believes it is at least one year ahead of its rivals and so wants to capitalise on its first mover
advantage.
DL Tourers has estimated that capital expenditure of £2,500,000 would be needed to set up the new
production line although this could be done in less than a month once the decision to proceed has been
taken. The normal policy of the company is to depreciate capital equipment over a 5 year period and to
assume a residual value at the end of year 5 equal to 20% of the initial cost.
It is anticipated that the new model would be sold in the first year at a price of £32,000. However, to
maintain the required demand increase and also to maintain competitiveness, DL Tourers expect to
have to reduce the price by 2% every year. The number of units sold are anticipated to be:
By the end of five years the Ecovan product will be in need of a complete design update and hence no
further sales are predicted to arise as a result of the current levels of investment planned.
Based on the above volumes, and taking into account process improvements and minor design changes
over the five-year product life, unit production cost estimates are estimated as follows:
Whilst the company is very keen on the new product, it also wishes to maintain the existing range of
caravans, which sell for an average price pf around £25,000. DL Tourers realises that Ecovan is
potentially so innovative that sales of existing models in the range will fall slightly, and feels it is prudent
to expect a reduced contribution from existing caravans totalling approximately £2,000,000 per year.
The accountant highlights that:
We have put so much effort into this design and some of the new features will be transferred to other
products once they have been tried and tested on Ecovan production. We are not fully utilizing the
factory at present and hence we only need to consider additional fixed overhead actually caused by
Ecovan production. You also should be aware that, although our WACC is 11%, we normally require new
projects to achieve a return of at least 25%. If the Ecovan project does not go ahead it is unlikely that the
factory space will be fully utilized for at least the next five years. Further investigation reveals that the
additional annual fixed overheads specifically related to the Ecovan will be as follows:
If the Ecovan project goes ahead an extra £170,000 working capital will be needed at the outset to
establish the inventory of specialist materials required in production.
Required:
Prepare a report for the Board of DL Tourers Ltd, giving clear advice on the financial viability of the
Ecovan project.
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