Trecor Co plans to buy a new machine to meet expected demand for a new product, Product T This machine will cost $250,000 and last for four years, at the end of which tume it will be sold for $5,000. Thecor Co expects demand for Product T to be as follows: Year Demand (units) 1 35.000 2 40.000 3 50,000 4 25,000 The selling price for Product T is expected to be $12.00 per unit and the variable cost of production is expected to be $7.80 per unit. Incremental annual fixed production overheads of $25,000 per year will be incurred. 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 Trecor 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 Trecor 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: (a) Calculate the net present value of buying the new machine and comment on your findings (work to the $1,000). nearest (b) Calculate the before-tax return on capital employed (accounting rate of return) based on the average investment and comment on your findings. (c) Discuss the strengths and weaknesses of internal rate of return in appraising capital investments.
Trecor Co plans to buy a new machine to meet expected demand for a new product, Product T This machine will cost $250,000 and last for four years, at the end of which tume it will be sold for $5,000. Thecor Co expects demand for Product T to be as follows:
Year Demand (units)
1 35.000
2 40.000
3 50,000
4 25,000
The selling price for Product T is expected to be $12.00 per unit and the variable cost of production is expected to be $7.80 per unit. Incremental annual fixed production overheads of $25,000 per year will be incurred. 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
Trecor 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 Trecor Co has a target return on capital employed of 20%.
Required:
(a) Calculate the
nearest
(b) Calculate the before-tax return on capital employed (accounting
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