Question
The Production Department of Meera Pewter Manufacturing Sdn Bhd, a small medium (SME) company had requested to buy a new digital machine to meet the
The Production Department of Meera Pewter Manufacturing Sdn Bhd, a small medium (SME) company had requested to buy a new digital machine to meet the current increasing demand for its pewter product. Meera Pewter Manufacturing Sdn Bhd plans to buy two (2) new digital machines at purchase price of RM120,000 each. For both machines, it requires an additional cost of RM7,000 for transportation and RM10,000 for goods and services tax plus import duties. Both, new digital machines are expected to have a useful life of five years (5) with a salvage value of RM20,000 each. Based on production forecasts, the new digital machine will increase production speed and efficiency. The new machines are expected to generate RM62,560 per year in earnings before taxes for five years. The company has two alternatives on how to finance the purchase of both machines: Alternative 1 - Borrow from a Commercial Bank: Bank Pembanguan Berhad The extract terms and condition of the loan are as follows: 1. The bank agreed to finance at full cost of machine with the interest rate charged at 9% per annum. 2. The bank will also charge 2% processing loan fee based on the total amount of loan which is to be paid in full in the first year. 3. Meera Pewter Manufacturing Sdn Bhd will pay using its own cash the 2% processing loan fee. Alternative 2 Loan from State Government Fund: Tabung Pembangunan Usahawan (TPU) As a SME company, Meera Pewter Manufacturing Sdn Bhd is eligible to apply loan from TPU, the State Government fund of which the extract terms and condition of the loan are as follows: 1. TPU agreed to finance the purchase price of the two (2) machines only. 2. Meera Pewter Manufacturing Sdn Bhd has to pay using its own cash the additional cost incurred. 3. TPU will charge the interest rate at 7% per annum with zero processing loan fees. All loan principal amounts will be repaid in one lump sum at the end of the fifth year. At present, the unlevered cost of equity and risk free rate are 14% and 5% respectively. The corporate tax rate is 25%. Required:
a. Determine the Adjusted Present Value (APV) of both alternatives above.
b. Based on answer in (a), recommend to the company whether to purchase or not to purchase the new machines and on which financing option is the best to be adopted.
c. Assess two (2) advantages of discounted cash flow technique.
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