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Excel Ltd. manufactures a special chemical for sale at * 40 per kg. The variable cost of manufacture is 25 per kg. Fixed cost excluding
Excel Ltd. manufactures a special chemical for sale at * 40 per kg. The variable cost of manufacture is 25 per kg. Fixed cost excluding depreciation is Rs 2,50,000. Excel Ltd. Is currently operating at 50% capacity. It can produce a maximum of 1,00,000kgs at full capacity The Production Manager suggests that if the existing machines are fully replaced the company can achieve maximum capacity in the next five years gradually increasing the production by 10% per year. The Finance Manager estimates that for each 10% increase in capacity, the additional increase in fixed cost will be Rs 50,000. The existing machines with a current book value of Rs 10,00,000 can be disposed of for Rs 5,00,000. The VicePresident (finance) is willing to replace the existing machines provided the NPV on replacement is about Rs 4,53,000 at 15% cost of capital after tax. You are required to compute the total value of machines necessary for replacement. For your exercise you may assume the following: The company follows the block assets concept and all the assets are in the same block. Depreciation will be on straight-line basis and the same basis is allowed for tax purposes. There will be no salvage value for the machines newly purchased. The entire cost of the assets will be depreciated over five year period. Tax rate is at 40%. Replacement outfiow will be at the beginning of the year (year 0 ). Discounting Factor. On the basis of data given above, the managing director feels that the replacement, if carried out, would at least yield post tax return of 15% in the three years provided the capacity build up is 60%,80% and 100% respectively. Do you agree
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