management accounting
Pero Three Co. manufactures automobile parts. As part of its expansion programme, it is considering the introduction of a new product since it has been approached by GS Motors (a multinational automobile manufacturer) to build this new product for their latest line of automobile. If the contract is accepted, it will increase Pero Three Co.'s tumover in the future. The contract to build and supply this new product for GS Motors spans over four years, although it is highly possible for Pero Three Co. to apply for subsequent contracts with GS Motors. The production director of Pero Three Co. has already prepared the following projections for this proposal: Year 1 Year 2 Year 3 Year 4 Sales Direct materials Direct labour Direct overheads Depreciation Pre-tax profit Corporation tax @ 30% After-tax profit (RM) (RM) (RM) (RM) 8.500,000 8,500,000 8,500,000 8.500,000 1,500,000 1,500,000 1,500,000 1,500,000 4.000.000 4,000,000 4,000,000 4,000,000 200,000 200.000 200,000 200,000 1,000,000 1,000,000 1,000,000 1,000,000 1,800,000 1,800,000 1,800,000 1,800,000 540,000 540,000 540,000 540,000 1,260,000 1,260,000 1,260,000 1,260,000 The production director has recommended that the project is viable because the cumulative after-tax profits over the four years is more than the capital cost of the project. Acting as the assistant to the management accountant at Pero Three Co., you have been asked to carry out a full financial appraisal of the proposal. The following information has been provided to assist you in your appraisal: Cost of equipment, RM4,000,000 (incurred at start of first year); Additional working capital, RM500,000 (incurred at start of first year and will be recovered in cash at the end of Year 4); The equipment will qualify for a 25% writing-down allowance on the reducing balance method; On ending the contract with GS Motors, any outstanding capital allowances can be claimed as a balancing allowance; At the end of Year 4 the equipment will be scrapped, with no expected residual value; The additional working capital needed does not qualify for capital allowances; Pero Three Co. pays corporation tax at the rate of 30% (assume that taxes are paid a year later); The company's cost of capital is 18%. Required: (a) Use the net present value technique to appraise the above contract and recommend whether it is worthwhile. (17 marks) (6) Identify and discuss TWO (2) reasons why your analysis is different from that produced by the production director. (4 marks) (c) Assume that you have suggested that this contract be accepted, discuss TWO (2) qualitative reasons why you would suggest to your financial director to accept this contract (hint: consider the case details given in this question). (4 marks) [Total: 25 Marks]
