Question

Rainbow Company, a medium-sized company specialized in the manufacture and
distribution of equipment for babies and small children, is evaluating a new capital
expenditure project. In a joint venture with another separate company it has invented a
remote controlled pushchair, one of the first of its kind on the market. It has been unable
to obtain a patent for the invention, but is sure that it will monopolize the market for the
first three years. After this, it expects to be faced with stiff completion.
The details are set out below:
1. The project has an immediate cost of K2, 100,000
2. Sales are expected to be K1, 550, 000 per annum for the first three years, falling
to K650, 000 per annum for the last two years.
3. Cost of sales is 40% of sales
4. Distribution costs represents 10% of sales.
5. The company’s cost of capital is 5%
Required:
a) Calculate the NPV of the project at the company’s required rate of return. State
whether the project is financially viable? [5 Marks]
b) Calculate the projects Internal Rate of Return (IRR) to the nearest percent.

Answer 1

The NPV and IRR is calculated in excel below