Microlin Ltd intends sot introduce a new product, T, into the market. This will require an investment in machinery costing Sh. 2,400,000. The machinery is estimated to have a useful life of four years with a terminal value of Sh600,000.
Additional information:
1. Capital allowances will be provided on the machinery at a rate of 12.5% per annum on a balanced basis. At the end of the useful life of the machinery, a balancing charge or allowance will arise equal to the difference between the scrap proceeds and the tax written down value.
2. Annual profits from the sale of product T will amount to Sh960,000 before deducting depreciation on machinery.
3. Corporation tax at a rate of 30% is payable one year after the end of the accounting year in which the tax was charged.
4. An investment in working capital amounting to Sh.240,000 will be required on the commencement of the project. This amount will however be recovered on completion of the project. 1. The start of the project coincides with the company's financial year. 2. the cost of capital is 15% per annum Required: Using the net present value (NPV) approach, advice the management on the suitability of the project. (10 marks)
Microlin Ltd intends sot introduce a new product, T, into the market. This will require an investment in machinery costing Sh. 2,400,000. The machinery is estimated to have a useful life of four years with a terminal value of Sh600,000.
Additional information:
1. Capital allowances will be provided on the machinery at a rate of 12.5% per annum on a balanced basis. At the end of the useful life of the machinery, a balancing charge or allowance will arise equal to the difference between the scrap proceeds and the tax written down value.
2. Annual profits from the sale of product T will amount to Sh960,000 before deducting depreciation on machinery.
3. Corporation tax at a rate of 30% is payable one year after the end of the accounting year in which the tax was charged.
4. An investment in working capital amounting to Sh.240,000 will be required on the commencement of the project. This amount will however be recovered on completion of the project. 1. The start of the project coincides with the company's financial year. 2. the cost of capital is 15% per annum Required: Using the net present value (NPV) approach, advice the management on the suitability of the project. (10 marks)
Related questions
The research and development department of SAMARINA SA has produced two designs of product XYZ: model One and model Two. The development costs incurred, and already paid; in getting the models to design stage are â¬100,000 for model One and â¬120,000 for model Two. However, management has decided that the company has the facilities to support production and sales of only one of the two models in the foreseeable future.
For model One, it requires an investment in machinery with an estimated useful life of five years. The machinery will cost â¬3,000,000 and possess a disposal value of â¬200,000 if resold during the first three years of ownership, and â¬80,000 thereafter.
For model Two, the machinery would cost â¬2,200,000, have a useful economic life of five years and a disposable value of â¬150,000 at any time after initial installation.
The marketing department has estimated the annual demand for each model for the five years commencing 1 January 2013, which is the expected time period over which either model would be sold. The financial planning department has produced the following estimated annual operating cash flows:
| Model One â¬000 | Model Two â¬000 | |
| 2013 | 420 | 800 |
| 2014 | 420 | 1,000 |
| 2015 | 1,000 | 450 |
| 2016 | 2,400 | 450 |
| 2017 | 1,200 | 450 |
It may be assumed that the annual operating cash flows will arise on the 31 of December in each year.
The companyâs money cost of capital is 12%.
You are required to:
(a) Calculate the following values for the investment proposals and discuss your findings of whether it is financially acceptable.
(i) net present value;
(ii) internal rate of return;
(iii) return on capital employed (accounting rate of return) based on average investment;
(iv) discounted payback period.
(b) Critically evaluate the use of NPV approach in proposed investments.
(c) Discuss what further information might be obtained to assist a fuller analysis.
