PART A

ITWEST Manufacturing is developing the incremental cash flows associated with the proposed replacement of an existing stamping machine with a new, technologically advanced one. Given the following costs related to the proposed project, explain whether each would be treated as a sunk cost or an opportunity cost in developing the incremental cash flows associated with the proposed replacement decision. (a) ITWEST could use the same dies and other tools (with a book value of $40,000) on the new stamping machine that it used on the old one. (b) ITWEST could link the new machine to its existing computer system to control its operations. The old stamping machine did not have a computer control system. The companys excess computer capacity could be leased to another company for an annual fee of $17,000. (c) ITWEST needs to obtain additional floor space to accommodate the new, larger stamping machine. The space required is currently being leased to another company for $10,000 per year. (d) ITWEST can use a small storage facility, built by ITWEST at a cost of $120,000 three years earlier, to store the increased output of the new stamping machine. Because of its unique configuration and location, it is currently of no use to either ITWEST or any other company. (e) ITWEST can retain an existing overhead crane, which it had planned to sell for its $180,000 market value. Although the crane was not needed with the old stamping machine, it can be used to position raw materials on the new stamping machine.

PART B

Amber Manufacturing Ltd is considering setting up a new manufacturing plant in Perth, WA. The company bought some land six years ago for $5.3 million in anticipation of using it as a warehouse and distribution site, but has since decided to rent facilities elsewhere. The land would sale for $7.7 million if it were sold today. The company now wants to build its new manufacturing plant on this land; the plant will cost $29.3 million to build, and the site requires $1,241,000 worth of grading before it is suitable for construction. What is the proper cashflow amount to use as the initial investment in non-current assets? Explain the treatment of each item you consider/do not consider in computing your answer. (You must show all workings needed to compute the cashflow.

PART C

Danys Potato Pty Ltd operates under classical tax system with a company tax rate of 30%. The company has 16,000 6.2% coupon bond outstanding with $1,000 par value and 25 years to maturity. The bond is currently selling at $1,080. The bonds make half-yearly coupon payment. The company has 535,000 shares outstanding which currently selling at $81 per share. The company also has 20,000 4.2% preference shares outstanding which are currently selling at $92 and the par value of these preference share is $100. The company is riskier than the market as represented by its systematic risk of 1.2. the market risk premium and the risk-free rate are 7% and 3.5% respectively. Danys Potato is planning to launch a new product, Ice Potato (they are freeze-dried to last longer) and the it paid $120,000 for a survey to determine the viability of the new product. The company expects the Ice Potato to generate sales of $835,000 per year. The fixed costs associated with the product is estimated to be $204,000 per year, and variable cost will be 20% of sales. The equipment necessary for production of Ice Potato will cost $865,000, which is the only initial cost for the production. The machine will be depreciated to zero over its four years life using straight-line method. Please note that the proposed Ice Potato project is identical to other existing projects of Danys Potato. Using Net Present Value (NPV) method determine if the company should undertake the Ice Potato project. Compute the IRR of this project and comment if the project should be accepted or rejected based on IRR. You must show all workings involved in solving this problem.