Last year, Bryce Canola Oil Company paid a consultant $12,000 to conduct an analysis on how to improve its operations. One outcome of this, resulted in a recommendation by the consultant, to consider the replacement of its operating equipment.

The company now plans to replace its old harvester machine with a new one, to speed up its production process. The machine will cost the company $1 million, inclusive of delivery and set-up charges. The machine can be depreciated on a straight-line basis over five years. This capital expenditure qualifies for the recently announced 4% investment allowance for agribusiness, by the Federal Government.

If the company proceeds with the replacement, the old harvester machine will be sold today, for $180,000. It hasnt been fully depreciated, and currently has a book value of $200,000.

The new harvester will speed up production in the canola fields by 50%, and the company expects revenues to increase from $1.2 million per year to $2.1 million per year. However, expanded production will increase operating costs by $440,000 each year. The new harvester will have to be insured at an additional cost of $25,000 per year, where insurance premiums are paid at the start of each year.

At the end of five years, the company expects to sell the new harvester for a salvage value of $290,000.

The company will incur a new bank loan to fund this purchase and the lender has indicated an interest rate of 7.5% p.a. The companys tax rate is 30%. The firm typically applies an after-tax required rate of return based on its WACC for routine equipment replacement proposals. This rate will be 9% p.a., considering the impact of the new bank loan. The company also typically prefers projects that take less than 2 years to recover the initial investment.

Tasks

• Set up a table of incremental cash flows over the useful life of this machine. (6 marks)
• Calculate the Net Present Value (NPV), Internal Rate of Return (IRR), the Profitability Index (PI) and the Payback Period for this investment proposal. (2 marks)

• Write a short paragraph (maximum 150 words) to explain if the company should or should not proceed with the investment project, based on your results for the projects NPV, IRR, PI and Payback Period.