QUESTION 1 ANSWER ALL PARTS OF THIS QUESTION a. Furnibase manufactures fine furniture. The company is...

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QUESTION 1 ANSWER ALL PARTS OF THIS QUESTION a. Furnibase manufactures fine furniture. The company is deciding whether to introduce a new mahogany dining room table set. The set will sell for 5,600, including a set of eight chairs. The company feels that sales will be 1,700, 1,925, 2,375, 2,450 and 1,820 sets per year for the next 5 years, respectively. Variable costs will amount to 45 per cent of sales, and fixed costs are 1.7 million per year. The new tables will require inventory amounting to 10 per cent of sales, produced and stockpiled in the year prior to sales. It is believed that the addition of the new table will cause a loss of 200 tables per year of the oak tables that the company currently produces. These tables sell for 4,500 and have variable costs of 40 per cent of sales. The inventory for this oak table is also 10 per cent of sales. To start production of the new dining room tables, the company needs to buy the necessary equipment today, which will cost 10.5 million. In 5 years, the new equipment will have a market value of 2.8 million. The equipment is depreciated to zero book value over a 5-year period using the straight-line method. The company has a tax rate of 38 per cent, and the required return for the project is 14 per cent. REQUIRED: Calculate NPV of the new project and comment on whether Furnibase should undertake the new project? [25 marks] b. Machine A costs 10,000 to buy and 3,000 per year to maintain. It is expected to last 3 years. Machine B costs 8,000 to buy and 5,000 per year to maintain. It is expected to last 2 years. Assume the discount rate is 7%. All else being, which machine should be purchased and why? [8 marks] c. Briefly explain why it is important for the financial analyst to focus on incremental cash flows. [5 marks] d. 'NPV is just a capital budgeting tool and as with any tool, it can be dangerous in the wrong hands.' Discuss this statement. In what way do sensitivity analysis, break-even analysis and scenario analysis improve things? [12 marks] QUESTION 1 ANSWER ALL PARTS OF THIS QUESTION a. Furnibase manufactures fine furniture. The company is deciding whether to introduce a new mahogany dining room table set. The set will sell for 5,600, including a set of eight chairs. The company feels that sales will be 1,700, 1,925, 2,375, 2,450 and 1,820 sets per year for the next 5 years, respectively. Variable costs will amount to 45 per cent of sales, and fixed costs are 1.7 million per year. The new tables will require inventory amounting to 10 per cent of sales, produced and stockpiled in the year prior to sales. It is believed that the addition of the new table will cause a loss of 200 tables per year of the oak tables that the company currently produces. These tables sell for 4,500 and have variable costs of 40 per cent of sales. The inventory for this oak table is also 10 per cent of sales. To start production of the new dining room tables, the company needs to buy the necessary equipment today, which will cost 10.5 million. In 5 years, the new equipment will have a market value of 2.8 million. The equipment is depreciated to zero book value over a 5-year period using the straight-line method. The company has a tax rate of 38 per cent, and the required return for the project is 14 per cent. REQUIRED: Calculate NPV of the new project and comment on whether Furnibase should undertake the new project? [25 marks] b. Machine A costs 10,000 to buy and 3,000 per year to maintain. It is expected to last 3 years. Machine B costs 8,000 to buy and 5,000 per year to maintain. It is expected to last 2 years. Assume the discount rate is 7%. All else being, which machine should be purchased and why? [8 marks] c. Briefly explain why it is important for the financial analyst to focus on incremental cash flows. [5 marks] d. 'NPV is just a capital budgeting tool and as with any tool, it can be dangerous in the wrong hands.' Discuss this statement. In what way do sensitivity analysis, break-even analysis and scenario analysis improve things? [12 marks]