Question
Composite Heavy Industry Pte Ltd is a local company involve in producing machineries for the heavy-industry sector. It has recently completed a $400,000 two-year marketing
Composite Heavy Industry Pte Ltd is a local company involve in producing machineries for the heavy-industry sector. It has recently completed a $400,000 two-year marketing study on whether to introduce a new machine to the market. Based on the results of the study, the company estimated that when the economy is good, they can sell 12,000 units but only 8,000 units sold if economy is bad. Probability for each economy is 50%. Each new machine can be sold annually over the next six years at a price of $9,615 each. Variable costs per machine are $7,400 with increases of 3% per year. Fixed costs total $12 million a year expected to remain constant. Working capital specifically for this project is estimated to be $2 million and will be returned at the end of the projects life. The cost of investment includes $40 million in machinery and building and another $2.4 million in land. The $40 million investment will be depreciated an expected residual value of $5 million over the life of the project at 40% reducing balance method for tax purposes. When the project ends, the land will be sold for an estimated $8.4 million. (Note : Land has no depreciation) Finally, start-up costs also entail fully tax-deductable expenses of $1.4 million, which are deductable at the end of the first year of production. The tax rate applicable to the company is 30%. The after-tax discount rate is 10%.
Required: a) Calculate the NPV of the project and advise Composite Heavy Industries Pte Ltd as to whether it should proceed with the project. b) If the management has a simple payback period of 2.5 years, will the project be accepted? c) What are three (3) disadvantages of the Internal Rate of Return? d) Describe how you would evaluate projects of different lifespan.
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