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machine expendit nstallatic ine, but

machine expendit nstallatic ine, but

FINANCIAL ACCOUNTING
FINANCIAL ACCOUNTING
10th Edition
ISBN:9781259964947
Author:Libby
Publisher:Libby
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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You have been asked to evaluate an investment for a manufacturing client to replace an existing machine with a new higher capacity alternative. She is very concerned about the scale of capital expenditure and needs definitive advice on whether it will give a worthwhile return. The purchase and installation will allow for additional sales capacity and an improved gross margin for a specific product line, but will also involve more training costs. She has provided you with this information: Sales of the current product line run at £1.2m a year. Demand considerably exceeds this level, but sales are constrained by the current machine's capacity limitation. The new machinery will allow an uplift of sales of 50% in the first year and assume a further 10% year-on-year growth in the subsequent years. The business historically made a Gross Margin in 40%. This will improve to 45% with the replacement machine. • The new machine will cost £980,000. Assume this is paid for immediately before the start of year 1. • The existing machine is still economically viable and has a resale value of £50,000 which will be received in the first year. • Labour costs of operating the new machine will be reduced from £300,000 per annum to £250,000 per annum. Assume these will remain constant at this level going forwards due to ongoing improvements in productivity. Extra training costs will be £30,000 in year 1 and £10,000 in year 2. A loan of £500,000 would be taken out over a five-year period to buy the machine and interest would be paid at 6% per annum. • All other costs in the business remain the same and are expressed in current prices. • For the purposes of this appraisal, you have been asked to evaluate the project over the next 5 years. Assume a Residual Value of the new machinery of £490,000 at the end of year 5. Ignore any issues concerning corporation tax. Ignore issues concerning the Covid-19 pandemic. work out the Net Present Value (NPV) of the project using a Discount Rate of 20%. Show your workings.
Transcribed Image Text:You have been asked to evaluate an investment for a manufacturing client to replace an existing machine with a new higher capacity alternative. She is very concerned about the scale of capital expenditure and needs definitive advice on whether it will give a worthwhile return. The purchase and installation will allow for additional sales capacity and an improved gross margin for a specific product line, but will also involve more training costs. She has provided you with this information: Sales of the current product line run at £1.2m a year. Demand considerably exceeds this level, but sales are constrained by the current machine's capacity limitation. The new machinery will allow an uplift of sales of 50% in the first year and assume a further 10% year-on-year growth in the subsequent years. The business historically made a Gross Margin in 40%. This will improve to 45% with the replacement machine. • The new machine will cost £980,000. Assume this is paid for immediately before the start of year 1. • The existing machine is still economically viable and has a resale value of £50,000 which will be received in the first year. • Labour costs of operating the new machine will be reduced from £300,000 per annum to £250,000 per annum. Assume these will remain constant at this level going forwards due to ongoing improvements in productivity. Extra training costs will be £30,000 in year 1 and £10,000 in year 2. A loan of £500,000 would be taken out over a five-year period to buy the machine and interest would be paid at 6% per annum. • All other costs in the business remain the same and are expressed in current prices. • For the purposes of this appraisal, you have been asked to evaluate the project over the next 5 years. Assume a Residual Value of the new machinery of £490,000 at the end of year 5. Ignore any issues concerning corporation tax. Ignore issues concerning the Covid-19 pandemic. work out the Net Present Value (NPV) of the project using a Discount Rate of 20%. Show your workings.
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