Question 7 JANUARY 2022 Semester Question 2 Rayz Corporation is considering the acquisition of an additional machinery for expansion purposes. Although the company has only been using its present facilities for the past three years, and is operating at full capacity of 10,000 units annually, the company is still unable to keep up with demand. The current market demand of 25,000 units is expected to last for another four years. The machinery under consideration costs $1,000,000 and will be able to double the company's current capacity. The useful life of the machinery is 10 years and can be sold for $200,000 at the end of year four or $30,000 at the end of year ten. An analysis of current operating data on a per unit basis is as follows: $ $ 35 Sales price 200 Variable costs: Manufacturing 97 Sales and admin 10 107 Fixed costs Manufacturinga 45 Sales and admin 25 70 23 3 Includes depreciation expense of existing machine Variable costs i=5 not expected to change with the acquisition of the additional machinery. However, fixed manufacturing costs (excluding depreciation on the new machine) is expected to increase by $250,000 annually. Further, the company expects to spend an additional $200,000 in fixed marketing costs per year Q additional sales. Management has set a minimum rate of return of 14% after tax for all capital investments. Assume that (i) additional revenues and expenses will result in cash flows in the same period; (ii) all cash flows occur at the end of the period; and iii) there is no difference between accounting and tax depreciation. The applicable tax rate is 35%. Required: a) Assume that the machinery is to be used and depreciated over four years on a straight-line basis. Compute the incremental effects on: (1) Annual aftertax operating income (ii) after-tax cashflows for each year (12 marks) b) For the potential acquisition of additional machinery, compute the following: (i) Payback period (ii)Accounting rate of return based on average investment (iii) Net present value. (10 marks) Note: PV factor for 14% are as follows: Year 1 = 0.877; Year 2 = 0.770; Year 3 = 0.675; Year 4 = 0.592; the PV annuity factor for 14%, 3 years = 2.322; the PV annuity factor for 14%, 4 years = 2.914) c) Based on your answers to (b), advise Rayz Corporation on the potential machinery acquisition. Explain your recommendation clearly. (8 marks)