The research and marketing department is planning to launch a new product in the market. The department has conducted a survey in the market which had cost $ 5,000. The following information has been gathered from the survey: 

Year                                                   1                  2                3                  4 

Forecasted demand (units)     70,000         80,000    100,000         50,000 

The selling price and costs are all in current price terms. Selling price $ 13 per unit Variable cost $ 9 per unit Incremental fixed production overheads $ 50,000 per annum The selling price and costs are forecasted to increase each year as follows: Increase Selling price 3% per year Variable cost 4% per year Incremental fixed production overheads 6% per year The company will be required to purchase a new high-tech machine which will cost $ 700,000 and has a life time of four years, at the end of which time it will be sold for $ 165,000. 

Additional information: 

1. The company has a real cost of capital 6% (after-tax) and general inflation is expected to be 4.717% per year. 

2. Annual allowances can be claimed at the rate of 25% on a reducing balance basis. 

3. Annual tax rate is 30% and is payable one year in arrears. 

4. The company has a target return on capital employed of 30% for new project. The accounting policy of the firm is to charge depreciation on a straight-line basis. 

REQUIRED 

(a) (i) Calculate the net present value of buying the new high-tech machine to manufacture the new product. 

(ii) Calculate the before-tax return on capital employed (accounting rate of return) based on the average investment. 

(b) Discuss your findings in each section of (a) above and advise whether the investment proposal is financially acceptable

Answer rating: 100% (QA)

a i Cost of capital 16 x 1472 1 11 NPV Sales units Selling Price Variable Cost Contribution per unit ... View the full answer