Michael plc is considering buying some equipment to produce a chemical named X14. The new equipment's...

 

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Michael plc is considering buying some equipment to produce a chemical named X14. The new equipment's capital cost is estimated at $100 million. If its purchase is approved now, the equipment can bé bought and production can commence by the end of this year, $50 million has already been spent research and development work. Estimates of revenues and costs arising from the operation of the new equipment are: Sales price ($/litre) Sales volume (million litres) Variable cost ($/litre) Fixed cost ($m) Year 1 100 0.8 50 30 Year 2 120 1.0 50 30 Year 3 120 1.2 40 30 Year 4 100 1.0 30 30 Year 5 80 0.8 40 30 If the equipment is bought, sales of some existing products will be lost resulting in a loss of contribution of $15 million a year, over the life of the equipment. The accountant has informed you that the fixed cost includes depreciation of $20 million a year the new equipment. It also includes an allocation of $10 million or fixed over-heads. A separate study has indicated that if the new equipment were additional overheads, excluding depreciation, arising from producing that the chemical would be $8 million a year. Production would require additional working capital of $30 million. For the purposes of your initial calculations ignore taxation. Required: (a) Deduce the relevant annual cash flows associated with buying the equipment. (b) Deduce the payback period. (c) Calculate the net present value using a discount rate of 8 per cent. (d) Explain (1) what is net present value investment appraisal method, (2) payback accounting rate of return and (3) internal rate of return (Hint: You should deal with the investment in working capital by treating it as a cash outflow at the start of the project and an inflow at the end.) Michael plc is considering buying some equipment to produce a chemical named X14. The new equipment's capital cost is estimated at $100 million. If its purchase is approved now, the equipment can bé bought and production can commence by the end of this year, $50 million has already been spent research and development work. Estimates of revenues and costs arising from the operation of the new equipment are: Sales price ($/litre) Sales volume (million litres) Variable cost ($/litre) Fixed cost ($m) Year 1 100 0.8 50 30 Year 2 120 1.0 50 30 Year 3 120 1.2 40 30 Year 4 100 1.0 30 30 Year 5 80 0.8 40 30 If the equipment is bought, sales of some existing products will be lost resulting in a loss of contribution of $15 million a year, over the life of the equipment. The accountant has informed you that the fixed cost includes depreciation of $20 million a year the new equipment. It also includes an allocation of $10 million or fixed over-heads. A separate study has indicated that if the new equipment were additional overheads, excluding depreciation, arising from producing that the chemical would be $8 million a year. Production would require additional working capital of $30 million. For the purposes of your initial calculations ignore taxation. Required: (a) Deduce the relevant annual cash flows associated with buying the equipment. (b) Deduce the payback period. (c) Calculate the net present value using a discount rate of 8 per cent. (d) Explain (1) what is net present value investment appraisal method, (2) payback accounting rate of return and (3) internal rate of return (Hint: You should deal with the investment in working capital by treating it as a cash outflow at the start of the project and an inflow at the end.)

Answer rating: 100% (QA)

a To deduce the relevant annual cash flows associated with buying the equipment we need to consider the cash flows for each year including revenues costs depreciation and additional overheads Lets cal... View the full answer