Question 2 (20 marks)

You must evaluate the purchase of a spectrometer for a firm. The base price is $140,000 and it would cost another $30,000 to modify the equipment for special use by the firm.

The equipment will be depreciated to zero value over the 3 years using prime cost (straight line) method. The machine would be sold after 3 years for $60,000. The machine would require a $8,500 increase in net working capital and fully recover at the end of its 3-year life. The equipment should save the firm $50,000 per year in before-tax labor costs.

Below shows the forecasted sales revenues, variable cost and fixed cost.

Sales quantity (units)

Selling price per unit

Fixed cost of production (per year) Variable cost of production (per unit)

Year 1 Year 2 4,000 5,000 $4 $4 $1,500 $1,500 $1.1 $1.1

Year 3 5,500 $4 $1,500 $1.1

(18

i.

ii.

The marginal tax rate is 40% and the discount rate is 10%.

What is the net present value (NPV) of the proposed project?

marks)

Advise should the project be accepted based on your answer in part (i)? (2 marks)

Please set out your work clearly and neatly. If you choose you can take advantage of the table below or you can continue your workings on the following page which has been intentionally left blank.