Question one

SC Co is evaluating the purchase of a new machine to produce product P , Which has a short product life-cycle due to rapidly changing technology .The machine is expected to cost $1 million . Production and sales of product P are forecast to be as follows :

Year	1	2	3	4
Production and sales (units/year)	35000	53000	75000	36000

The selling price 0f product P (in current price terms )will be $20 per unit, while the variable cost of the product (in current price terms )will be $12 per unit .Selling price inflation is expected to be 5% per year. No increase in existing fixed costs is expected since SC co has spare capacity in both spare and labourterms .

Production and selling product P will call for increased investment in working capital . Analysis of historical levels of working capital within SC Co indicates that at the start of each year , investment in working capital for product P will be need to be 7% of sales revenue for that year .

SC Co pays tax of 30% per year in the year in which the taxable profit occurs ,liability to tax is reduced by capital allowances on machinery (tax allowable depreciation ) , which SC Co can claim on a straight line basis over the four-year period .SC Co uses a nominal (money terms ) after-tax cost of capital of 12% for investment appraisal purposes.

Required :

1. Determine the after tax cash-flows associated with the purchase of a new machine to purchase product P .(12) marks
2. Calculate the net present value of the proposed investment in product P.(6) marks
3. Compute the internal rate of return of the proposed investment in product P.(6)marks
4. Advise on the acceptability of the proposed investment in product P and discuss the limitations of the evaluations you have carried out.(8)marks
5. Discuss hoe the net present value method of investment appraisal contributes towards the objective of maximizing the wealth of shareholders .(8)marks