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Olourun Ltd is the major employer in the Front Hill area, where the firm is located. The company is considering the acquisition of a new

Olourun Ltd is the major employer in the Front Hill area, where the firm is located. The company is considering the acquisition of a new production line. The equipment would cost$720 000 and installation cost would amount to $59 000. At the end of its 5-year life, it is expected to be disposed of at its salvage value of $70 000. The new equipment would allow the company to expand production significantly, which would require an increase in working capital of $90 000. If the purchase is made, the firm's maintenance costs would be reduced by $60 000 annually. However, at the end of the third year, a major overhaul would have to be undertaken at a cost of $80 000. Operating cash flows would be $220 000 in the first year; this would increase by 2% for of the following years.

The company's cost of capital is 14% and the relevant corporate tax rate is 25%

a)Calculate the relevant after-tax net cash flows and after-tax profits over the life of the investment.[10 marks]

b)Compute the project's ARR[5 marks]

c)What is the payback period?[5 marks]

d)Using the NPV as the basis of your decision, advise Olourun as to whether the company should purchase the equipment.[7 marks]

e)Would you advise the company to base their decision on the payback method rather than the NPV as used above?[5 marks]

f)Compute the IRR of the project[12 marks]

g)The company is considering another investment would have an initial cost of $800 000 and an NPV of $65000.There is a situation of capital rationing, and you have suggested that the firm should use the profitability index to choose which investment to implement. Advise the company.[

h)Discuss THREE non-financial factors which the firm should consider when making this decision.

i)Why is it important for the company to know its cost of capital when making investment decisions?

(Total 30 marks)

Question 2

Toyota Motor Corporations is a leading car manufacturer in the world through the sale of its flag ship model the Corolla.The company decided to upgrade this model by changing the platform. As such, Toyota made a vertical acquisition and bought 90% stake in Yamaha, and engine and electronic component company.The company's management saw this as a strategic move to gain ahead of all the other car manufacturers who also depends on Yamaha parts.

1.Define transfer pricing and determine how the objectives could aid in the strategy of Toyota be ahead of the competition.(7 Marks)

2.Discuss the benefits of any three method of transfer pricing outline which would be most suitable to aid in Toyota's strategy.(15 Marks)

Part 2

Yamaha Company has two divisions, Electronic Division and Instrument Division. For several years, Electronic Division has manufactured a special glass container, which it sells to Instrument Division at the prevailing market price of $20. Electronic Division produces the electrical component containers only for Instrument Division and does not sell the product to outside customers. Annual production and sales volume is 20,000 containers. A unit cost analysis for Electronic Division showed the following:

Cost CategoriesCosts per Container

Direct materials$3.50

Direct labor, 1 hours2.30

Variable overhead7.50

Avoidable fixed costs: $30,000 /20,0001.50

Corporate overhead: $18 per direct labor hour4.50

Variable shipping costs1.20

Unit cost$20.50

Corporate overhead represents the allocated joint fixed costs of production building depreciation, property taxes, insurance, and executives' salaries. A profit markup of 20 percent is used to determine transfer prices.

Required:

3.What would be the appropriate transfer price for Electronic Division to use in billing its transactions with Instrument Division(2 Marks)

4.If Electronic Division decided to sell some containers to outside customers, would your answer to requirement 3 change? Defend your response.(4 Marks)

5.What would be the transfer price EXCLUDING all fixed cost?(2 Marks)

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