Question
Read and comprehend the questions below. Answer the questions using the relevant information, examples, corporate theories and empirical studies. Question Wanbay Bhd. is considering expanding
Read and comprehend the questions below. Answer the questions using the relevant information, examples, corporate theories and empirical studies.
Question
Wanbay Bhd. is considering expanding its production capacity by purchasing a new machine, the ADK0100. The cost of the ADKO100 is RM2.75 million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a RM60,000 feasibility study to analyse the decision to buy the ADKO100, resulting in the following estimates:
Marketing: Once the ADKO100 is operating next year, the extra capacity is expected to generate RM10 million per year in additional sales, which will continue for the 10-year life of the machine.
Operations: The disruption caused by the installation will decrease sales by RM5 million this year. Once the machine is operating next year, the cost of goods for the products produced by the ADKO100 is expected to be 70% of their sale price. The increased production will require additional inventory on hand of RM1 million to be added in year 0 and depleted in year 10.
Human Resources: The expansion will require additional sales and administrative personnel at a cost of RM2 million per year.
Accounting: The ADKO100 will be depreciated via the straight-line method over the 10-year life of the machine. The firm expects receivables from the new sales to be 15% of revenues and payables to be 10% of the cost of goods sold. Wanbay Bhd.s marginal corporate tax rate is 25%.
The appropriate cost of capital for the expansion is 10%.
The expected new sales could range from RM8 million to RM12 million but the most likely one is at RM10 million per year from the expansion. Analyse the case and advise the management of the company whether or not the machine ADKO100 should be purchased.
In addition to using sensitivity analysis, you should also show the break-even level of new sales from the expansion and the break-even level for the cost of goods sold.
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