Question 2

Lee conducted an analysis for the issue described in Question 1.The Chief Financial Officer (CFO), who was pleased with Lees work, revealed that the required rate of return for this replacement proposal should be 15%. The CFO asked Lee to further investigate the project.

Required:

a. Find the NPV, PI and IRR of this replacement proposal. Based on your findings, should the replacement be carried out?

b. Explain why you will not use the payback period method to evaluate this replacement proposal.

c. Assume that the purchasing manager is negotiating with the COMS supplier for a discount on the purchase price. What is the minimum percentage discount that the supplier should offer in order to attract Tech Motor to purchase the system?

Question 1 (30 marks) Tech Motor is a leading manufacturer of alloy wheels for car enthusiasts. Lee is the financial manager of the firm and is responsible for analysing the company's financial issues. The production department has proposed the purchase of a new CNC One-stop Manufacturing System (COMS) to improve the production capacity and quality of its alloy wheels. The new manufacturing system is expected increase the firm's net revenue (before taxes and depreciation expenses) by $240,000 in each of the next four years. Lee has also obtained the following information from the production manager: Proposed situation Existing situation Initial purchase price $1,500,000 $1,000,000 Shipping and installation cost $300,000 $200,000 Required net working capital $430,000 $350,000 Annual cost of maintenance $260,000 $320,000 Current market value (CMV) Not applicable $800,000 Expected salvage value $0 Existing usage O years 2 years Expected economic life 4 years 6 years Tech Motor uses the straight-line depreciation method on all its production machinery with the marginal tax rate of 18%. Answer the following questions. a. Determine the initial outlay associated with this proposed purchase. (8 marks) b. What are the annual after-tax cash flows associated with this project for Years 1 to 3? Also, determine the after-tax cash flow at the terminal year (Year 4)? (14 marks) c. Discuss how the tax rules on depreciation affect the firm's asset purchase investment decision. (8 marks) $0