Capital markets and finance
Author John Perfrement Melbourne Polytechnic T1 2017
General instructions
QUESTION 1
The company LT Ltd is considering the introduction of a new product. Generally the companys products have a life of about 5 years after which they are deleted from the range of products that the company sells. The new product requires the purchase of new equipment costing $400000. The ATOs depreciation schedule allows an effective life of 10 years for such equipment and that the company chooses to use the Diminishing Value Method for tax purposes meaning the annual tax depreciation rate would be 50% higher than the rate connected with prime cost depreciation. Assume that at the end of 5 years the equipment can be disposed of easily and will generate proceeds of $157500.
The new product will be manufactured in a factory already owned by the company. The factory originally cost $150000 to build and has a current resale value of $350000 which should remain fairly stable over the next 5 years. This factory is currently being rented to another company under a lease agreement that has 5 years to run and provides for an annual rental of $15000. Under the lease agreement LT Ltd can cancel the lease by paying the lessee an amount equal to 1 years rental payment.
It is expected that the product will involve the company in sales promotion expenditures which will amount to $50000 during the first year the product is on the market. Additions to net operating working capital will require $22500 at the commencement of the project and are assumed to be fully recoverable at the end of year 5.The new product is expected to generate net operating cash flows as follows before tax:
Year 1 $200000
Year 2 $250000
Year 3 $325000
Year 4 $300000
Year 5 $150000
Required rate of return is 10% and the company tax rate is 30%.Calculate the NPV.Show all calculationsand ignore the existence of any applicable GST
QUESTION 2
Nutson Bolz is an assembly business run by a sole proprietor whose marginal tax rate is 47%. The owner is considering the purchase of a new fully automated machine to replace an older manually operated one. The machine being replaced now five years old originally had an expected life of ten years and it was being depreciated using the straight-line method from a cost of $20000 down to zero and could be sold for $15000. The old machine was operated by one operator who earned S15000 per year in salary and $2000 per year in fringe benefits. The annual costs of maintenance and defects associated with the old machine were 57000 and $3000 respectively.
The replacement machine being considered has a purchase price of $50000 a salvage value after five years of $10000 and would be fully depreciated over five years using the straight-line depreciation method. To get the automated machine in running order there would be a $3000 shipping fee and a $2000 installation charge. In addition because the new machine would work faster than the old one investment in raw materials and goods-in-process inventories would need to be increased by a total of $5000. The annual costs of maintenance and defects on the new machine would be $2000 and $4000 respectively. The new machine also requires maintenance workers to be specially trained; fortunately a similar machine was purchased three months ago and at that time the maintenance workers went through the $5000 training program needed to familiarize themselves with the new equipment. The firm’s management is uncertain whether to charge half of this $5000 training fee to the new project. Finally to purchase the new machine it appears the firm would have to borrow an additional $20000 at 10% interest from its local bank resulting in additional interest payments of $2000 per year. The required rate of return on projects of this kind is 20%.
Required:
show all caculations