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Question 1 [25 marks] Corns Pty (Ltd) must replace a machine that it uses to produce maize flour. The existing machine does not have the
Question 1 [25 marks] Corns Pty (Ltd) must replace a machine that it uses to produce maize flour. The existing machine does not have the capacity that the company requires. The management of the firm has identified a possible new machine to replace the existing one. You have been tasked with evaluating the financial acceptability of the machine. This will assist management, since they will have objective information regarding which of the machines to investigate further and discuss with possible suppliers. The bookkeeper of the company provided you with the following information: The company is taxed at 28% The machine will be depreciated on a straight-line basis over the usable life of the project. The company is financed wholly by equity. The company has a beta of 1.5 associated with it, the risk free rate is 10% and the market risk premium 6%. The project is expected to generated sales of R1000 000 per year in today's terms. Inflation is 6%. Capital gains are taxed at a rate of 22% on 67% of the gain. . The financial manager of the firm e-mailed you the following: All of our projects are evaluated taking inflation and risk into account. For inflation, we adjust the estimated real cash flows to nominal values. Only sales and variable costs should be adjusted however. We use our weighted average cost of capital (WACC) to evaluate projects. The cash flows expected to be generated by the machine have been estimated as follows: Cash flows Purchase price Sales generated per year (in real terms) Associated variable costs Fixed costs associated with the machine Increase in net operating working capital Economic lifespan Residual value at end of economic life Machine (R000's) 2000 1000 50% of sales 100 200 5 years 2500 Required: Determine the net present value of the machine and comment on the financial acceptability thereof. Also, discuss the risk involved, the effect of capital gains tax and the effect of inflation on the expected acceptability of the machine
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