Teddy Co plans to buy a new machine to meet expected demand for a new product, Product T. This machine will cost K250,000 and last for four years, at the end of which time it will be sold for K5,000. Teddy Co expects demand for Product T to be as follows: Year 1 2 3 4 Demand (units) 35,000 40,000 50,000 25,000 The selling price for Product T is expected to be K12.00 per unit and the variable cost of production is expected to be K7.80 per unit. Incremental annual fixed production overheads of K25,000 per year will be incurred. Selling price and costs are all in current price terms. Selling price and costs are expected to increase as follows: Increase Selling price of Product T: 3% per year Variable cost of production: 4% per year Fixed production overheads: 6% per year Other information Teddy Co has a real cost of capital of 5.7% and pays tax at an annual rate of 30% one year in arrears. It can claim capital allowances on a 25% reducing balance basis. General inflation is expected to be 5% per year. Teddy Co has a target return on capital employed of 20%. Depreciation is charged on a straight-line basis over the life of an asset. Required Calculate the net present value of buying the new machine and comment on your findings (work to the nearest K1,000). Calculate the before-tax accounting rate of return based on the average investment and comment on your findings.
Teddy Co plans to buy a new machine to meet expected demand for a new product, Product T. This machine will cost K250,000 and last for four years, at the end of which time it will be sold for K5,000. Teddy Co expects demand for Product T to be as follows:
Year 1 2 3 4
Demand (units) 35,000 40,000 50,000 25,000
The selling price for Product T is expected to be K12.00 per unit and the variable cost of production is expected to be K7.80 per unit. Incremental annual fixed production
Selling price and costs are expected to increase as follows:
Increase
Selling price of Product T: 3% per year
Variable cost of production: 4% per year
Fixed production overheads: 6% per year
Other information
Teddy Co has a real cost of capital of 5.7% and pays tax at an annual rate of 30% one year in arrears. It can claim capital allowances on a 25% reducing balance basis. General inflation is expected to be 5% per year.
Teddy Co has a target return on capital employed of 20%.
Required
- Calculate the
net present value of buying the new machine and comment on your findings (work to the nearest K1,000). - Calculate the before-tax accounting
rate of return based on the average investment and comment on your findings.
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