Case 1: An Irish company, Leprechaun, that sells imported game consoles online is
evaluating two mutually exclusive new products, only one of which will be accepted.
The company’s cost of capital is 11%.
Option 1: Game Console X
This project to launch Game Console X will have a five-year life. Leprechaun thinks
that the market for this console will become too competitive due to improvements in
visual techniques after five years, so it will stop selling this product and launch new
products after that. Selling price per unit in the first year is expected to be Euro 14.55.
Materials and shipping costs are expected to be Euro 3.30 and Euro 7.20 per unit
respectively in the first year. The selling price and the cost of shipping per unit are
expected to increase by 6% per year in the third and subsequent years. Materials cost
per unit is expected to increase by 5% per year in the third and subsequent years.
80,000 units are expected to be produced and sold in the first year; in the second and
subsequent years this figure is expected to increase to 110,000 units. Investment in
working capital is expected to increase by Euro 135,000 at the start of the project and
will be reversed at the end of the project life.
Initial cost of Euro 1,425,000 is to be paid now. Assets used in the project will have a
useful life of five years, after which they will be sold on for a value of Euro 75,000. The
company will apportion per year Euro 30,000 of its head office administrative costs to
this project.
Option 2: Game Console Y
This project to launch Game Console Y will have a three-year life. The company has
already spent Euro 80,000 on the design of this product. An initial outlay of Euro
1,275,000 is to be paid now with a further Euro 300,000 in one year’s time. The annual
revenue is expected to be Euro 1,110,000 in year 1 rising by Euro 135,000 each
subsequent year. Operational costs are expected to be Euro 450,000 in year 1 rising
by Euro 112,500 each subsequent year.
At the end of the project, assets will be sold for a value of Euro 375,000. Investment
in working capital is expected to increase by Euro 60,000 at the start of the project and
will be reversed at the end of the project life. The company will apportion per year Euro
50,000 of its head office administrative costs to this project.
With regard to the development of Console Y, some management will have to leave
aside work on other projects, resulting in delays and reduced income from these
projects amounting to Euro 75,000 per year.
Originally when designing the two Consoles, Leprechaun has talked to factories in
East Europe for the production of both X and Y in 2022. Leprechaun is to launch either
Game Console X or Y in summer 2025.
Requirement:
You are the Chief Financial Officer of Leprechaun. You are required to present a report
to the board of directors and management team of Leprechaun, addressing the
following:
a). Evaluate and recommend which Game Console the company should proceed with,
using the Net Present Value technique. Word limit: 300 words.
(30%)
b). Discuss how rapid technological change could impact the assumptions. Word limit:
150 words.
c). You should include a discussion of possible impact of post supply chain disruptions
post covid. Word limit: 150 words.
(30%)
Case 2: Discuss the application of investment appraisal techniques using discounted
cash flows methods, its advantages and drawbacks using a worked example with a
discount rate of 5%. Word limit: 1,000 words.
