Question 3 Farmers Alliance is evaluating an investment proposal to manufacture product DD3 which requires an...

 

Transcribed Image Text:

Question 3 Farmers Alliance is evaluating an investment proposal to manufacture product DD3 which requires an investment in new machinery. It has performed well in test marketing trials conducted recently by the company's R&D department which costs the company GHC500,000 and recorded as part of initial cost of investment in machinery. The Management Accountant has prepared the following information relating to the investment proposal: Initial investment in machinery Selling price(current price terms) Expected selling price inflation Variable operating costs(current price terms Fixed operating costs (current price terms) Expected operating cost inflation GHC9 million GHC40 per unit 3% per year GHC16 per unit The R&D department has prepared the following demand forecast as a result of its test marketing trials. The forecast reflects expected technological change and its effect on the anticipated life cycles of product DD3. 1 Year Demand(units) 120,000 It is expected that all units of product DD3 produced will be sold, in line with the company's policy of keeping no inventory of finished goods. No terminal value or machinery scrap value is expected at the end of four years, when production of productDD3 is planned to end. The machine attracts 25% capital allowance. Farmers Alliance uses a nominal (money) discount rate of 15% per year and a target return on capital employed of 25% per year. Corporation tax is 25% and paid in the same year as related profit. The target payback period is 3 years for the company. GHC340,000 per year 4% per year 2 140,000 (i) Net present value (ii) Internal rate of return 3 240,000 4 90,000 (a) Identify and briefly explain the key stages in the capital investment decision making process, and the role of investment appraisal in this process. [3 marks] (b) Evaluate the proposal using the following techniques: [12 marks] [4 marks] [2 marks] (ii) Discounted payback period (c) Discuss your findings in each section of (b) above and advise whether the investment proposal is financially viable. [4 marks] [Total: 25 marks] Question 3 Farmers Alliance is evaluating an investment proposal to manufacture product DD3 which requires an investment in new machinery. It has performed well in test marketing trials conducted recently by the company's R&D department which costs the company GHC500,000 and recorded as part of initial cost of investment in machinery. The Management Accountant has prepared the following information relating to the investment proposal: Initial investment in machinery Selling price(current price terms) Expected selling price inflation Variable operating costs(current price terms Fixed operating costs (current price terms) Expected operating cost inflation GHC9 million GHC40 per unit 3% per year GHC16 per unit The R&D department has prepared the following demand forecast as a result of its test marketing trials. The forecast reflects expected technological change and its effect on the anticipated life cycles of product DD3. 1 Year Demand(units) 120,000 It is expected that all units of product DD3 produced will be sold, in line with the company's policy of keeping no inventory of finished goods. No terminal value or machinery scrap value is expected at the end of four years, when production of productDD3 is planned to end. The machine attracts 25% capital allowance. Farmers Alliance uses a nominal (money) discount rate of 15% per year and a target return on capital employed of 25% per year. Corporation tax is 25% and paid in the same year as related profit. The target payback period is 3 years for the company. GHC340,000 per year 4% per year 2 140,000 (i) Net present value (ii) Internal rate of return 3 240,000 4 90,000 (a) Identify and briefly explain the key stages in the capital investment decision making process, and the role of investment appraisal in this process. [3 marks] (b) Evaluate the proposal using the following techniques: [12 marks] [4 marks] [2 marks] (ii) Discounted payback period (c) Discuss your findings in each section of (b) above and advise whether the investment proposal is financially viable. [4 marks] [Total: 25 marks]

Answer rating: 100% (QA)

a The key stages in the capital investment decision making process are as follows 1 Identify the need for investment this may be due to an increase in demand for the companys products or the need to r... View the full answer