VS Tech Berhad manufactures a thermostat that can be use in a range of kitchen appliances. The manufacturing process is, at present, semi-automated. The equipment used cost RM540,000 and has carrying value of RM300,000. Demand for the products has been fairly stable and output has been maintained at 50,000 units a year in recent years.

The following data, based on the current level of output, have been prepared in respect of the product:

Using existing equipment		Per unit
		RM	RM
Selling price			12.40
Labour		(3.30)
Materials		(3.65)
Overheads:	Variable	(1.58)
	Fixed	(1.60)
			(10.13)
Operating profit			2.27

Although the existing equipment is expected to last for a further four years before it is sold for an estimated RM40,000, the business has recently been considering purchasing new equipment that would completely automate much of the production process. This would give rise to production cost savings. The new equipment would cost RM670,000 and would have an expected life of four years, at the end of which it would be sold for an estimated RM70,000. If the new equipment is purchased, the old equipment could be sold for RM150,000 immediately.

The assistant to the businesss accountant has prepared a report to help assess the viability of the proposed change, which includes the following data:

Using new equipment		Per unit
		RM	RM
Selling price			12.40
Labour		(1.20)
Materials		(3.20)
Overheads:	Variable	(1.40)
	Fixed	(3.30)
			(9.10)
Operating profit			3.30

Depreciation charges will increase by RM 85,000 a year as a result of purchasing the new machinery, however, other fixed costs are not expected to change.

In the report the assistant wrote:

The figures shown above that relate to the proposed change are based on the current level of output and take account of a depreciation charge of RM150,000 a year in respect of the new equipment. The effect of purchasing the new equipment will be to increase the operating profit to sales revenue ratio from 18.3% to 26.6%. In addition, the purchase of the new equipment will enable us to reduce our inventories level immediately by RM130,000.

In view of these facts, I recommend purchase of the new equipment.

The business has a cost of capital of 12 per cent.

As a Head of Finance, you are required to prepare a written report for the board meeting explaining the proposal to purchase a new equipment by stating in the report:

1. Statement of the incremental cash flows arising from the purchase of the new equipment.
2. Calculation of net present value of the proposed purchase of new equipment.
3. Reasons, whether the business should purchase the new equipment or not.
4. Explanation why cash flow projections are used rather than profit projections to assess the viability of proposed capital expenditure projects.