Case Study

Fruit$-$To$-$Go $($FTG$)$ processes fruit for shipping overseas.

FTG commissioned a study to look into the feasibility of changing the packaging of

the fruit from cans to sealed bags. The Consultant charged $$45000$ for the report. The

report concluded that the new packaging will increase sales and reduce some

operating costs.

The new packaging machinery will cost $$1,100,000.$ The new machine is expected to

last $5$ years. The Taxation Office advise the life of the machine, for tax purposes, is $4$

years. The new machine is depreciated by straight$-$line method.

The old canning machinery was purchased $2$ years ago for $$800,000$ and was being

depreciated at $$200,000$ and will be for the next $2$ years. The old machine could be

sold today for $$130,000.$ In $5$ years it will be worth nothing.

Installing the new machine will require staff training $($a tax deductible expense$)$ of

$$35000$ before production can commence. Due to the lower cost of the bags Inventory

required will be reduced by $$100,000$ for the life of the project.

The new sales of bagged fruit is expected to be $$750,000$ in Year $1$ rising by $20\%$ for

$1$ year then $10\%$ for the rest of the life of the project. Variable Costs associated with

the new packaged fruit are $40\%$ of sales.

Canned fruit production will be discontinued. Sales of canned fruit were static at

$$400,000$ with variable costs of $$200,000(50\%$ of Sales$).$

The new equipment is very hi$-$tech. Maintenance costs are expected to be higher at

$$40,000$ per year. Maintenance costs on the old machine were $$30000$ per year.The

lighter packaging will reduce annual freight cost significantly from $$250,000$ to

$$140,000$ per year.

Fixed costs are expected to remain at $$450,000$ per year.

At the end of the project the new machinery can be sold for $$350,000.$

Notes:

The company tax rate is $30\%.$

The required rate of return is $12\mathrm{.}5\%.$

Requirement:

You are required to answer and to conduct a capital budgeting analysis of the

company. You must determine:

The cash flows at the start

The cash flows over the life

The cash flows at the end

The appropriate discount rate