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

Trax Ltd is considering the replacement of outdated equipment, which will allow the firm to manufacture a new line of products. The cost of the new equipment is $8.5m and the company qualifies for a depreciation deduction of 40% of cost, for the first year and 20% in each of the subsequent three years. The equipment is also expected to reduce the cost of producing an existing product line by $180 000,00 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 equipment is $2,1 million in four years time. The new line of products will result in a selling price of $85,00 per unit and variable cost of $38,00 per unit. The product line is expected to result in a constant demand of 70 000 units per annum for four years.

The current tax value of the present equipment is $300 000,00, and the current market value is $410,00 000. The current equipment qualified for a depreciation allowance of 20% per annum on a straight-line basis when it was purchased as used machinery two years ago. The equipment is expected to have a residual value of zero in four years time.

The investment in net working capital, which will occur at the beginning of the year, will amount to $475 000,00, and this working capital balance will be recovered at the end of year 4. The marginal tax rate is 28% and the firm has a cost of capital of 12%.

QUESTION:

The marketing department is unsure of the projected demand for the product and wishes to know how far annual demand may fall if the project is still to achieve a zero NPV, assuming a constant annual sale?