|ASOP Co is considering an investment in new technology that will reduce operating costs through increasing energy efficiency and decreasing pollution. The new technology will cost $1.05 million and have a four- year life, at the end of which it will have a scrap value of $70,000. A licence fee of $94,000 is payable at the end of the first year. This licence fee will increase by 3.75% per year in each subsequent year. A working capital of $ 19,000 is also required at the beginning of the process with an inflation of just 3%. The new technology is expected to reduce operating costs by $5.80 per unit in current price terms. This reduction in operating costs is before taking account of expected inflation of 4.5% per year. Forecast production volumes over the life of the new technology are expected to be as follows: Year 1 2. 3 4 Production (units per year) 60,000 75,000 95,000 80,000 If ASOP Co bought the new technology, it would finance the purchase through a four-year loan paying interest at an annual before-tax rate of 9.5 % per year. Alternatively, ASOP Co could lease the new technology. The company would pay four annual lease rentals of $373,000 per year, payable in advance at the start of each year. The annual lease rentals include the cost of the licence fee. If ASOP Co buys the new technology it can claim capital allowances on the investment on a 25% reducing balance basis. The company pays taxation one year in arrears at an annual rate of 30%. ASOP Co has an after-tax weighted average cost of capital of 12.59% per year. Required : 1. Calculate NPVs and Comment which option is better? (20+10+2) 2. Calculates IRRs for both the options. (5+5) 3. Calculate and comment :Sensitivity of Savings. (6+2) |ASOP Co is considering an investment in new technology that will reduce operating costs through increasing energy efficiency and decreasing pollution. The new technology will cost $1.05 million and have a four- year life, at the end of which it will have a scrap value of $70,000. A licence fee of $94,000 is payable at the end of the first year. This licence fee will increase by 3.75% per year in each subsequent year. A working capital of $ 19,000 is also required at the beginning of the process with an inflation of just 3%. The new technology is expected to reduce operating costs by $5.80 per unit in current price terms. This reduction in operating costs is before taking account of expected inflation of 4.5% per year. Forecast production volumes over the life of the new technology are expected to be as follows: Year 1 2. 3 4 Production (units per year) 60,000 75,000 95,000 80,000 If ASOP Co bought the new technology, it would finance the purchase through a four-year loan paying interest at an annual before-tax rate of 9.5 % per year. Alternatively, ASOP Co could lease the new technology. The company would pay four annual lease rentals of $373,000 per year, payable in advance at the start of each year. The annual lease rentals include the cost of the licence fee. If ASOP Co buys the new technology it can claim capital allowances on the investment on a 25% reducing balance basis. The company pays taxation one year in arrears at an annual rate of 30%. ASOP Co has an after-tax weighted average cost of capital of 12.59% per year. Required : 1. Calculate NPVs and Comment which option is better? (20+10+2) 2. Calculates IRRs for both the options. (5+5) 3. Calculate and comment :Sensitivity of Savings. (6+2)
