FINANCIAL MANAGEMENT

QUESTION 1

Plantech Ltd manufactures components for the motor industry. The company is considering increasing the level of automation of the production process for one of its product lines. This is expected to result in a reduction in the number of defective units produced as well as reducing the level of inventory for existing component lines. Plantech will be required to replace the existing equipment, which will also enable the firm to manufacture a new line of components. The cost of the new equipment is

R 3 300 000. The new equipment qualifies for a depreciation deduction of 40% of cost in the first year and 20% of cost in each of the three subsequent years. The company will need to employ a system operator at a cost of R 240 000 per annum.

The production of new component lines will require the company to hold inventory of R 750 000 for the new lines and this investment in working capital will be recovered at the end of four years. Increased automation will, however, result in a reduction in the working capital required to support current production and it is expected that the inventory required to support production of existing lines will be reduced by R 480 000 immediately. The production of existing product lines will end in four years time. The equipment is expected also to reduce the cost of producing an existing product line by R 360 000 per annum before-tax for another four years when the life of this product line is expected to end. The expected residual value of the new equipment is

R 1 800 000 in four years time. The new line of components will result in a selling price of R 390 per unit and a variable cost of

R 336 per unit. The product line is expected to result in a constant demand of 12 000 units per annum for four years.

The current tax value of the present equipment is R 600 000 and the current market value is R 1 125 000. The current equipment qualified for a depreciation deduction of 20% per annum on straight-line when it was purchased three years ago as used machinery. The equipment is expected to have a residual value of R 300 000 in four years time. The marginal tax rate is 28% and the firm has a cost of capital of 12%.

REQUIRED:

1.1 Calculate the net present value (NPV) of the project.

1.2 What is the break-even number of units in terms of the project to achieve a zero NPV?