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Task C (35 marks)

You have 2 options to choose between: Task C1 - Capital Investment Analysis (Equipment Replacement) Task C2 - A report on the Capital Asset Pricing Model

If you decide to do both C1 and C2, we will only mark C1

Task C1 - Capital Investment Analysis (Equipment Replacement)

Blunt Edge Pty Ltd is a tool manufacturing company based in Sydney. The entity's income tax rate is 30%. It is considering the replacement of a manually operated machine with a fully automated model. One man is currently needed to operate the machine. This costs the company $120,000 p.a. in wages, holiday loading, superannuation payments and other remuneration-connected expenditure. The $120,000 includes amounts spent on paying for labor when the normal operator goes on holiday or calls in sick. The machine's maintenance costs are $8,000 per year.

The manually operated machine was bought 2 years ago for $50,000. The Australian Tax Office schedule includes the asset in the 10-year useful-life category and only allows prime cost depreciation (with no residual) for this type of equipment. This is effectively the straight-line depreciation method. The company believed that the machine normally would be taken out of service at the 10-year point. The current disposal value of the machine presently in use is $42,000. We are confident we will receive that in the second-hand equipment market.

The new model has a purchase price of $200,000. Shipping and installation would cost $15,000. Maintenance on the new machine would be $17,500 p.a. but the adoption of that machine would cut the cost of defects from $5,000 to $1,250 per year.

The new machine is in an 8-year useful life tax category and again prime cost depreciation (with no residual) is the only method available. As the machine will undergo heavy use, the company believes the 8 years may be quite accurate.

Required:

a) Determine the cash flows associated with this project.

b) Given that the required rate of return is 11%, compute the Net Present Value (NPV)

c) What is the Internal Rate of Return (IRR) of the project?

d) What is the Profitability Index (PI) of the project?

e) Advise if you would or would not recommend replacing the manual machine with the automated one and

why?