Question $5[20$ Marks$]$

Trax Ltd is a manufacturer of high$-$quality plastic products made to demanding specifications, which makes replication of design difficult. The company relies on digital marketing programmes to ensure that its models are constantly updated, and demand follows new designs. This allows maintaining margins in a highly competitive environment.

Trax is considering replacing its outdated equipment with efficient modern models, which will enable the company to manufacture a new line of products. The new equipment will cost R$8\mathrm{.}5$ million and the company will qualify for a depreciation deduction. The equipment is expected also to reduce the cost of producing the existing product line by R$180000$ per annum before$-$tax for another four years, when the life of this product line is expected to end.

The expected residual value of the new equipment is R$2\mathrm{.}1$ million in four years$$ time. The new line of products will result in a selling price of R$85$ per unit and a variable cost of R$38$ per unit. The product line is expected to result in a constant demand of $70000$ units per annum of four years.

The current market value of the present equipment is R$410000.$ The equipment is expected to have a residual value of zero in four years$$ time.

MBA$5903$

OCTOBER$/$NOVEMBER $2022$ EXAMINATION

$7$

The investment in net working capital, which will occur at the beginning of the year, will amount to R$475000,$ and this working capital balance will be recovered at the end year $4.$ The marginal tax rate of $27\%$ and the company has a cost of capital of $12\%.$

Required:

$5\mathrm{.}1.$ Determine the project$$s net present value $($NPV$).$ Ignore the impact of tax depreciation$/$allowance on both old and new equipment in the calculations. $(12)$

$5\mathrm{.}2.$ Determine the project$$s payback. $(3)$

$5\mathrm{.}3.$ Despite the wide use of the payback method in practice, it has disadvantages. Briefly discuss these. $(2)$

$5\mathrm{.}4.$ Recommend to management whether to proceed with the replacement of the new equipment.