You are the Chief Operating Officer (COO) of an electrical appliances company, Sung-Sam. Currently you are considering replacing the existing old assembly line with a new one in order to boost the production capacity and product variety. The old assembly line was purchased seven years ago at a total cost of $2.4 million. It has a 12-year economic life with five years remaining and zero salvage value. If this assembly line was to be sold today, it would be worth $1 million. The new assembly line is proposed by Pro-M, a consulting firm with expertise in manufacturing consultancy. The proposed assembly line is currently selling at $1.4 million. In addition, Sung-Sam would have to incur $120,000 shipping and installation expenses and HK$80,000 investment in net working capital. The economic life of the new assembly line is five years with zero scrap value. It is expected that the new assembly line can reduce before- tax operating expenses by $220,000 every year. The company has paid $20,000 to Pro-M to obtain an evaluation report on the new assembly line. Sung-Sam uses the straight line depreciation method on all its production machinery and sets the cost of capital to be 18%. Assume that the marginal tax rate is 25%. Answer the following questions: a What is a sunk cost in capital budgeting? Do you agree that the $20,000 to Pro-M is a sunk cost? Why? (6 marks) b What is the initial outlay associated with this proposed purchase? (6 marks) 16 FIN B280 Introduction to Financial Management c What are the annual after-tax cash flows associated with this proposed purchase for years one through to four? What is the after- tax cash flow in terminal year (year 5)? (8 marks) d Calculate the net present value (NPV) of this replacement decision. Would you accept the purchase of the new assembly line? Explain your reason with concept of the goal of the firm.

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a A sunk cost is a cost that has already been incurred and cannot be recovered I agree that the 2000... View the full answer