NotSoWise Products Company manufactures several different products. One of the firm's principal products sells for Rs. 20 per unit. The sales manager of NotSoWise Products has stated repeatedly that he could sell more units of this product if they were available. In an attempt to substantiate his claim, the sales manager conducted a market research study last year at a cost of Rs. 44,000 to determine potential demand for this product. The study indicated that NotSoWise Products could sell 18,000 units of this product annually for the next 5 years. The equipment currently in use has the capacity to produce 11,000 units annually. The variable production costs are Rs. 9 per unit. The equipment has a book value of Rs. 60,000 and a remaining useful life of 5 years. The salvage value of the equipment is now negligible and will be zero in 5 years.

A maximum of 20,000 units could be produced annually on new machinery. The new equipment costs Rs. 300,000 and has an estimated useful life of 5 years, with no salvage value at the end of 5 years. NotSoWise Products' production manager has estimated that the new equipment, if purchased, would provide increased production efficiencies that would reduce the variable production costs to Rs. 7 per unit.

NotSoWise Products Company uses straight-line depreciation on all its equipment for tax purposes. The firm is subject to a 40 percent tax rate, and its after-tax cost of capital is 15 percent.

The sales manager felt so strongly about the need for additional capacity that he attempted to prepare an economic justification for the equipment although this was not one of his responsibilities. His analysis presented below, disappointed him because it did not justify acquisition of the equipment.

He computed the required investment as follows:

Purchase price of new equipment Rs. 300,000 Disposal of existing equipment

Loss on disposal Rs. 60,000

Less tax benefit (40%)	24,000	36,000
Cost of market research study Total investment		44.000 Rs. 380,000
He computed the annual returns as follows: Contribution margin from product Using the new equipment [18,000 X (Rs. 20 - Rs. 7)] Using the existing equipment [11,000 x (Rs. 20 - Rs. 9)]		Rs. 234,000 121,000
Increase in contribution margin		Rs. 1 13,000
Less depreciation		60,000
Increase in before-tax income		Rs. 53,000
Income tax (40%)		21,200
Increase in income Less 15% cost of capital on the additional investment required (0.15 X Rs. 380,000)		Rs. 31,800 57,000
Net annual return on proposed investment in new equipment		Rs. (25,200)

The controller of the Company plans to prepare a discounted cash flow analysis for this investment proposal. The controller has asked you to prepare corrected calculations of

1. the required investment in the new equipment and
2. the recurring annual cash flows. Explain why your corrected calculations differ from the original analysis prepared by the sales manager.
3. Calculate the net present value of the proposed investment in the new equipment.