Bathroom Boss is a manufacturer of a wide range of wall and floor-mounted bathroom vanities.
After a recent visit to an international trade show, the management of Bathroom Boss is evaluating a proposal to acquire a new item of machinery. The new machine will be used to fabricate natural-look, artificial-stone benchtops. Compared to the existing technologies, the new machine can fabricate benchtops with less hazardous materials.
Other key details and estimates associated with the new machine are supplied below:
• The new equipment will cost $7.5 million and will have a 5-year useful life. The machine's installation costs are expected to total $150,000. It will also cost the firm $75,000 to test the new machine and train staff in its operation.
• In the first year of its operation, the new machine is expected to grow the firm's revenues by $2.2 million. These sales are expected to grow by 2% p.a. over the life of the machine.
• On average, the cost of sales is 42% of sales revenue.
• As a result of the installation of the new machine, operating costs are expected to grow by $200,000 p.a. These costs are expected to grow by 1.5% p.a. over the life of the machine.
• The firm will spend $600,000 in year 1 to promote the new machine to customers.
• The new equipment will require a major maintenance service in years 2 and 4. These services will cost $85,000 and $90,000, respectively.
The firm’s tax rate is 30%. The firm requires a 15% required rate of return on all potential investments. All calculations must be performed in Excel.
Required
In relation to the above proposal:
1. Calculate the annual after-tax cash flows (5 marks) and annual after-tax profit.
2. Calculate the payback period
3. Calculate the net present value
4. Calculate the internal rate of return.
5. Calculate the accounting rate of return based on the average and initial investment.
6. Based on an assessment of the above, strategic factors, and sustainability factors, discuss whether the firm should go ahead with the proposal.
7. Discuss how sensitive your recommendations are to changes in assumptions in regard to the financial impact of the new capital investment. In your discussion, include examples that illustrate how changes to at least two assumptions impact the financial analysis.
Ensure that your answers for the above are discussed and supported by relevant calculations/ workings.