A publicly traded company called ADA Co. intends to spend $5 million on new machinery to accommodate the growing demand for its goods. The equipment would be in use for four years before being replaced. The machinery is anticipated to have a scrap value of 5% of the purchase price. With a balancing allowance or charge claimed in the last year of operation, capital allowances would be available on a 25% reducing balance basis on the cost of the machinery. With this investment, production capacity will rise by 9,000 units annually, and it is anticipated that all of these units will be sold as they are created. The following financial data is pertinent in terms of current prices:: Forecast inflation Selling price $650 per unit 4·0% per year Variable cost $250 per unit 5·5% per year Incremental fixed costs $250,000 per year 5·0% per year A $500,000 initial working capital investment will be needed in addition to the initial cost of the new equipment. Working capital investments will be impacted by the predicted general inflation rate of 4.7% per year. ADA Co. pays 20% in annual tax on profits, one year in advance. The business has an annual nominal after-tax cost of capital of 12%.

Required:

(a) Using a nominal (money terms) method, determine the net present value of the anticipated purchase of the new machinery and offer your opinion on its financial viability. (b)

Compare and contrast the two methods of estimating net present value: the nominal (money terms) approach and the real terms approach. (c)

Describe TWO financial goals of a publicly traded company, such as ADA Co, and how each of these goals is supported by its planned investment in new equipment.

Answer rating: 100% (QA)

SOLUTION a To determine the net present value NPV of the anticipated purchase of the new machinery we can use the following steps Calculate the increm... View the full answer