(b) Comfort Limited has produced and marketed traveling bags for several years. In the recent months,...

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(b) Comfort Limited has produced and marketed traveling bags for several years. In the recent months, several of its competitors have introduced much lighter bags to the market. The company is concerned about the effect this will have on its sales in the near future. Accordingly, the company is considering investing in new technology that would enable them to produce a much lighter and more compact bags. Production of lighter bags will require the purchase of new machinery at a cost of BDT 5,750,000 and is expected to have a life of four years with a scrap value of BDT 150,000. Tax depreciation of 25% on reducing balance is available on this machinery. The machinery is expected to produce 30,000 units per annum. In addition, an investment of BDT 180,000 in working capital will be required initially. Production costs of each bag (at year 1 prices) are estimated as follows: Direct material BDT 10.00 Direct labor Variable overheads 12.00 15.00 In addition, fixed production costs (at year 1 prices), excluding depreciation on plant and machinery, will amount to BDT 250,000 per annum. The selling price of each unit will be BDT 200.00 per unit (at year 1 prices). Demand is expected to be 28,000 units per annum for the next four years. The retail price index is expected to be at 6% per annum for the next four years and the selling price of bags is expected to increase at the same rate. Annual inflation rates for production costs are expected to be as follows: Direct material Direct labor Variable overheads Fixed costs 12% 8% 4% 6% The company's cost of capital in money terms is expected to be 16%. Corporate tax is charged at 30% and is paid in two installments, with half of the tax payable in the year in which it arises, and the balance paid in the following year. Required: (i) Recommend whether Comfort Limited should invest in new machinery to produce lighter bags. (ii) Comment on the sensitivity of result computed in (i) above to the initial investment. ESTION 3 (b) Comfort Limited has produced and marketed traveling bags for several years. In the recent months, several of its competitors have introduced much lighter bags to the market. The company is concerned about the effect this will have on its sales in the near future. Accordingly, the company is considering investing in new technology that would enable them to produce a much lighter and more compact bags. Production of lighter bags will require the purchase of new machinery at a cost of BDT 5,750,000 and is expected to have a life of four years with a scrap value of BDT 150,000. Tax depreciation of 25% on reducing balance is available on this machinery. The machinery is expected to produce 30,000 units per annum. In addition, an investment of BDT 180,000 in working capital will be required initially. Production costs of each bag (at year 1 prices) are estimated as follows: Direct material BDT 10.00 Direct labor Variable overheads 12.00 15.00 In addition, fixed production costs (at year 1 prices), excluding depreciation on plant and machinery, will amount to BDT 250,000 per annum. The selling price of each unit will be BDT 200.00 per unit (at year 1 prices). Demand is expected to be 28,000 units per annum for the next four years. The retail price index is expected to be at 6% per annum for the next four years and the selling price of bags is expected to increase at the same rate. Annual inflation rates for production costs are expected to be as follows: Direct material Direct labor Variable overheads Fixed costs 12% 8% 4% 6% The company's cost of capital in money terms is expected to be 16%. Corporate tax is charged at 30% and is paid in two installments, with half of the tax payable in the year in which it arises, and the balance paid in the following year. Required: (i) Recommend whether Comfort Limited should invest in new machinery to produce lighter bags. (ii) Comment on the sensitivity of result computed in (i) above to the initial investment. ESTION 3

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