An Australian Stock Exchange listed ice cream manufacturing company with its operations conducted solely in Hong Kong
Question:
An Australian Stock Exchange listed ice cream manufacturing company with its operations conducted solely in Hong Kong currently produces 200,000 units of product per year. The company is a fully- owned subsidiary of a large United States company with most shareholders located in the United States, Canada, and Hong Kong.
The company currently buys its self-sealing containers with all labelling attached from an outside supplier at a price of $2 per container. The plant manager believes that it would be cheaper for the company to make these containers rather than buy them.
The necessary machinery would cost $150,000 and would have an anticipated operational lifespan of 10 years at which time it would have no salvage value. The total cost of this investment in machinery can be written off for taxation purposes on a straight-line basis over a
7-year term. It is not expected that the machinery would have any salvage value at the end of 10 years. Direct production costs are estimated to be $1.50 per container.
The plant manager estimates that the operation to make these containers rather than buy them would require additional working capital of $30,000 allocated as;
investment in debtors $14,000 and investment in initial stock of $16,000. The plant manager however argues that this sum ($30,000) can be ignored in any financial assessment since the amount is fully recoverable at the end of the 10-year period over which the proposed machinery will be operational.
Assume that the company pays Australian company tax at a marginal rate of 30% in the same year that taxable income is earned, its after-tax cost of capital is 15% and all operating cash flows occur at the end of the year.
Required:
a) What is the after-tax annual cost of continuing to buy the self-sealing containers from the outside supplier? Show all calculations.
b) Draw a cash-flow diagram / timeline providing as much relevant information as possible (number of periods, amount of payments and relevant interest rate(s)) for the cash flows arising from continuing to buy the self-sealing containers from the outside supplier over the term of the capital budgeting project analysis.
Expert Answer:
Step 1 Capital budgeting Capital budgeting is a process of evaluating different pro... View the full answer
