Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

CanCan reported the following selected data for the year ended December 31, 2022: Average operating assets $4,500,000 Operating Income After Tax 350,000 Tax rate 30%

CanCan reported the following selected data for the year ended December 31, 2022:

Average operating assets $4,500,000
Operating Income After Tax 350,000
Tax rate 30%

Included in the operating assets is a bottling machine which was acquired 4 years ago at a cost of $780,000. Although, this machine is still in good condition, management is considering replacing the existing bottling machine with an energy efficient machine. The current market value of the existing machine is $200,000 and the residual value is $20,000 if disposed at the end of 6 years. The following is the annual expenses associated with the existing bottling machine:

Annual expenses: Existing bottling machine
Direct materials $180,000
Direct labour 240,000
Quality Control 80,000
Factory Maintenance 60,000
Depreciation 76,000

On January 10, 2023, a manufacturer is offering to sell a new bottling machine to CanCan at a price of $940,000. The machine would last for 6 years and has an expected residual value of $40,000. The new machine will reduce $20,000 of inventory at the beginning; however, this amount will be tied up at the end of the 6th year. With the new machine, CanCan expects to reduce the prime costs by 20% and the manufacturing overhead costs, excluding depreciation, by 40%. CanCan has a minimum desired rate of return of 4% and a cutoff period of 4 years in evaluating the new project. Managers who are being evaluated using Residual income (RI) are unsure whether this is a good idea.

a)

CanCan financed the old bottling machine by borrowing 50% from a local bank, with 4% interest rate, raising 20% from new shareholders, with 8% required rate of return, and the rest from retained earnings, with 5% required rate of return.

Calculate the effective cost of debt: %
Calculate the effective cost of new shares: %
Calculate the effective cost of retained earnings: %
Calculate the WACC: %

b)

Calculate the Cost of Capital, using the WACC: $
Calculate the Economic Value-Add (EVA): $
Calculate the residual income (RI): $

c)

Calculate the net initial investment: $
Calculate the total annual cost saving: $
Calculate the present value of the total annual cost savings (Rounded to the nearest dollar.) : $
Calculate the total terminal value: $
Calculate the present value of the total terminal value (Rounded to the nearest dollar.) : $
Net Present Value (Rounded to the nearest dollar.) : $

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Strategic Management Theory And Cases An Integrated Approach

Authors: Charles W. L. Hill, Melissa A. Schilling, Gareth R. Jones

13th Edition

0357033841, 978-0357033845

More Books

Students also viewed these Accounting questions