Oceanblue plc produces sea turbines and are considering buying supplementary equipment that will decrease manpower needs to produce a unit from 5 manhours to 2 manhours. The main machinery has 3 more periods of useful life. If the supplementary equipment is purchased, the existing (main) machine will not be sold at a scrap value of $10,000. The production units are estimated depending on the state of the green industry, as follows:
Industry
Period 1
Period 2
Period 3
Weak (probability 70%)
2,000 units
3,000 units
2,500 units
Strong (probability 30%)
8,667 units
9,667 units
14,167 units31
The employee hourly rate for the coming period is £7.00, rising in period 2 and period 3 to
£8.00 and £9.00 respectively.
The supplementary equipment has a capital cost of £300,000 with an estimated residual value at the end of period 3 of £60,000. Capital allowances are at 25% on a reducing balance basis. The company pays corporation tax at a rate of 30% per period. The authorities will provide a one-off cash grant of $5,000 at the end of the first year.
The company assesses projects of this type using a discount rate of 5% per period. Any difference between the written down value and proceeds from the sale may be claimed as a tax credit. Taxes are considered one period in arrears. Required:
a)
Calculate the annual cost savings for periods 1, 2 and 3.
b)
Calculate the taxable profits for periods 1, 2 and 3.
c)
Calculate the total cash flows for each period.
d)
Calculate the expected net present value of the project suggesting whether the
company should invest in the supplementary equipment.