Question

Sohar steel SAOG is currently planning the launch of a new product. A market study was recently conducted to find out the likely demand for the product and the study concluded that the demand for the new product would last for five years. The total cost of survey is OMR 20,000 and this is due for payment immediately. The cost of market study will be written off in two years. Based on the market study information, the following summary is prepared:

Year	1	2	3	4	5
Sales (OMR'000s)	240	250	180	150	160
Cost of Sales (OMR'000s)	180	170	120	110	100
Gross profit (OMR'000s)	40	80	60	40	60
Variable costs (OMR'000s)	40	30	22	18	18
Fixed costs(OMR'000s)	22	22	22	22	22
Market study cost written off (OMR'000s)	10	10	0	0	0
Net Profit before tax (OMR'000s)	-12	18	16	0	20

An existing machine with a written down value of OMR100,000 can be used for the production of the new product with an additional renovation cost of OMR 5,000 and the machine could be sold at the end of the five-year period for OMR 15,000. Additional working capital of OMR15,000 will be required immediately and will be released at the end of the period. The fixed overheads include depreciation of the machine. The expected rate of return of the company is 11.5%. Company is in the tax bracket of 20%.

Required:

Compute the IRR of the new product.

Answer 1

Computation of Net cash Flow
(Figures in OMR,000)
Year	1	2	3	4	5
Sales	240	250	180	150	160
Cost of Sales	180	170	120	110	100
Gross profit	60	80	60	40	60
Variable costs	40	30	22	18	18
Fixed costs	22	22	22	22	22
Market study cost (payment to be made immidiately)	20	0	0	0	0
Net Profit before tax (OMR'000s)	-22	28	16	0	20
tax @ 20%	-4.4	5.6	3.2	0	4
Tax Expenses (assumed loss of year 1 will be adjusted against tax liability of 2nd year)	0	1.2	3.2	0	0.8
Net profit after tax	-22	26.8	12.8	0	19.2
Depreciation (tax saving)	4.2	4.2	4.2	4.2	4.2
Additional working capital	-15	0	0	0	15
Net Cash Flow	-32.8	31	17	4.2	38.4

Statement showing Net Present Value (NV)
(Figures in OMR,000)
Years	Net Cash Flow	Present Value Factor (PVF) @ 11.5%	PV of Cash Flow
1	-32.8	0.89686	-29.42
2	31	0.80436	24.94
3	17	0.72140	12.26
4	4.2	0.64699	2.72
5	38.4	0.58026	22.28
Net Presnt Value of product	32.78

Depreciation (figures in OMR):

cost of asset	100000
additional cost	5000
useful life	5 years
Depreciation per year	21000
tax saving @20%	4200