Question 31c
PV Co, a large stock-exchange-listed company, is evaluating an investment proposal to manufacture Product W33, which has performed well in test marketing trials conducted recently by the company’s research and development division. Product W33 will be manufactured using a fully-automated process which would significantly increase noise levels from PV Co’s factory. The following information relating to this investment proposal has now been prepared:
| Initial investment | $2 million |
|---|---|
| Selling price (current price terms) | $20 per unit |
| Expected selling price inflation | 3% per year |
| Variable operating costs (current price terms) | $8 per unit |
| Fixed operating costs (current price terms) | $170,000 per year |
| Expected operating cost inflation | 4% per year |
| Year | 1 | 2 | 3 | 4 |
|---|---|---|---|---|
| Demand (units) | 60,000 | 70,000 | 120,000 | 45,000 |
It is expected that all units of Product W33 produced will be sold, in line with the company’s policy of keeping no inventory of finished goods. No terminal value or machinery scrap value is expected at the end of four years, when production of Product W33 is planned to end. For investment appraisal purposes, PV Co uses a nominal (money) discount rate of 10% per year and a target return on capital employed of 30% per year. Ignore taxation.
Required:
(c) Discuss how the objectives of PV Co’s stakeholders may be in conflict if the project is undertaken. (5 marks)