Teddy Co plans to buy a new machine to meet the expected demand for a new product, Product T. This machine will cost K250,000 and last for four years, at the end of which time it will be sold for K5,000. Teddy Co expects demand for Product T to be as follows:

 

Year                                        1                      2                      3                      4

Demand (units)                       35,000             40,000             50,000             25,000

 

The selling price for Product T is expected to be K12.00 per unit and the variable cost of production is expected to be K7.80 per unit. Incremental annual fixed production overheads of K25,000 per year will be incurred. The selling price and costs are all in current price terms.

 

Selling price and costs are expected to increase as follows:

Increase

Selling price of Product T:                              3% per year

Variable cost of production:                           4% per year

Fixed production overheads:                          6% per year

 

Other information

Teddy Co has a real cost of capital of 5.7% and pays tax at an annual rate of 30% one year in arrears. It can claim capital allowances on a 25% reducing balance basis. General inflation is expected to be 5% per year.

 Teddy Co has a target return on capital employed of 20%. Depreciation is charged on a straight-line basis over the life of an asset.

 Required

1. Calculate the net present value of buying the new machine and comment on your findings (work to the nearest K1,000).                                                                            
2. Calculate the before-tax accounting rate of return based on the average investment and comment on your findings.                                                                            

Answer rating: 100% (QA)

a Net Present Value A B D E F G H 1 a Net Present Value 2 3 Year 3 4 5 4 Sales 436800 519168 674918 ... View the full answer