1. CycleReady plc produces a variety of accessories for cyclists; it has recently designed an innovative new cycle pump (the Cyclone) which it feels it can protect from competition for four years by taking out a patent. It could potentially be a major investment for the company if it links up with large producers of bicycles and pumps are sold as additional items with new bicycles.
The company has already incurred
New machinery costing £15 million will be purchased on 30 September 2022 and it is estimated that it can be sold for £9 million on 30 September 2026. The company
The new equipment will attract 18% reducing balance capital allowances in the year of expenditure and in every subsequent year of ownership by the company, except the final year. In the final year, the difference between the equipment’s written down value for tax purposes and its disposal proceeds will give rise to either a balancing allowance or a balancing charge.
It would start production and sales of the Cyclone on 1 October 2022. Sales volumes over the four years are estimated at 1 million, 2 million, 3 million and 2 million units for the years ending 30 September, 2023, 2024, 2025 and 2026. It is felt that the cyclone could be sold for £10 in current price. Variable costs are estimated at £6 per item in current price.
This project requires the use of a specialized piece of equipment which will be leased for 4 years; the cost in the first year of the project will be £2 million but it will then increase at 2% per annum. Lease payments will be made on the first day of production of each year.
The company will need additional finance and is intending to take out a bank loan of £8 million for the duration of the project. The loan is likely to charge interest at 7% per annum.
Working capital will be required at the start of each year equivalent to 8% of the revenue in that year; all working capital will be recovered at the end of the project.
Selling price will inflate at 4% per annum, variable costs at 5% and fixed costs at 2%.
The corporation tax rate is 20% and tax is payable at the end of the year to which it relates. As it has many other operations, any reduction in tax will benefit the company in the year to which it relates.
The company has a money cost of capital of 12% and always works to the nearest £000.
QUESTIONS:
(a) Using money cash flows, calculate the
Step by step
Solved in 3 steps
