Teddy Co wants to purchase a new Equipment to meet a rising demand for a new product, Product X. This Equipment will cos
Posted: Mon May 09, 2022 10:57 am
Teddy Co wants to purchase a new Equipment to meet a rising demand for a new product, Product X. This Equipment will cost K300,000 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 K14.00 per unit and the variable cost of production is expected to be K8.80 per unit. Incremental annual fixed production overheads of K15,000 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: 6% per year
Variable cost of production: 4% per year
Fixed production overheads: 3% 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
a) Calculate the net present value in future value terms of purchasing the new Equipment and comment on your findings (work to the nearest K1,000). (15 marks)
b) Calculate the before-tax accounting rate of return based on the average investment and comment on your findings. (5 marks)
c) Calculate the internal rate of return and comment on your findings.
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 K14.00 per unit and the variable cost of production is expected to be K8.80 per unit. Incremental annual fixed production overheads of K15,000 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: 6% per year
Variable cost of production: 4% per year
Fixed production overheads: 3% 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
a) Calculate the net present value in future value terms of purchasing the new Equipment and comment on your findings (work to the nearest K1,000). (15 marks)
b) Calculate the before-tax accounting rate of return based on the average investment and comment on your findings. (5 marks)
c) Calculate the internal rate of return and comment on your findings.