Uftin Co is a large company which is listed on a major stock market. The company has been evaluating an investment proposal to manufacture Product K3J. The initial investment of $1,800,000 will be payable at the start of the first year of operation. The following draft evaluation has been prepared by a junior employee.
Year | 1 | 2 | 3 | 4 |
Sales (units/year) | 95,000 | 100,000 | 150,000 | 150,000 |
Selling price ($/unit) | 25 | 25 | 26 | 27 |
Variable costs ($/unit) | 11 | 12 | 12 | 13 |
(Note: The above selling prices and variable costs per unit have not been inflated.) |
$'000 | $'000 | $'000 | $'000 | |
Sales revenue | 2,475 | 2,605 | 4,064 | 4,220 |
Variable costs | (1,097) | (1,260) | (1,890) | (2,048) |
Fixed costs | (155) | (155) | (155) | (155) |
Interest payments | (150) | (150) | (150) | (150) |
Cash flow before tax | 1,073 | 1,040 | 1,869 | 1,867 |
Tax allowable depreciation | (450) | (450) | (450) | (450) |
Taxable profit | 623 | 590 | 1,419 | 1,417 |
Taxation | (137) | (130) | (312) | |
Net cash flow | 623 | 453 | 1,289 | 1,105 |
Discount at 12% | 0.893 | 0.797 | 0.712 | 0.636 |
Present values | 556 | 361 | 918 | 703 |
$'000 | ||||
Present value of cash inflows | 2,538 | |||
Cost of machine | (1,800) | |||
NPV | 738 |
The junior employee also provided the following information:
- Relevant fixed costs are forecast to be $150,000 per year.
- Sales and production volumes are the same and no finished goods inventory is held.
- The corporation tax rate is 22% per year and tax liabilities are payable one year in arrears.
- Uftin Co can claim tax allowable depreciation of 25% per year on a reducing balance basis on the initial investment.
- A balancing charge or allowance can be claimed at the end of the fourth year.
- It is expected that selling price inflation will be 4.2% per year, variable cost inflation will be 5% per year and fixed cost inflation will be 3% per year.
- The investment has no scrap value.
- The investment will be partly financed by a $1,500,000 loan at 10% per year.
- Uftin Co has a weighted average cost of capital of 12% per year.
Requirements:
a
Prepare a revised draft evaluation of the investment proposal and comment on its financial acceptability.
Marks: 11
b
Explain any TWO revisions you have made to the draft evaluation in part (a) above.
Marks: 4
Answers submitted
Created by | Ref | Marking | Action |
---|---|---|---|
a 9950 |
11 | ||
a 9820 |
11 | ||
b 9952 |
4 | ||
c 9954 |
5 | ||
b 9822 |
4 | ||
c 9824 |
5 | ||
a 9130 |
11 | ||
a 6256 |
11 | ||
a 8900 |
11 | ||
c 6264 |
5 | ||
a 8408 |
11 | ||
a 8410 |
11 | ||
a 8354 |
11 | ||
b 7522 |
4 | ||
c 7520 |
5 | ||
a 7180 |
11 | ||
a 7178 |
11 |
- 1 of 5
- next ›