Accounting Equation Capital Investment Homework Help
- November 29, 2017
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- Category: Accounting
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The management of the company is planning to expand operations by replacing existing equipment (with EM and JB models) along with purchasing new machinery. (The Matz and Ebz)
The investment decision regarding the new machinery to be purchased involves a choice between two types of equipment which have the trade names ‘Matz’ and ‘Ebz’. The initial outlays required for the two alternative proposals (given in Exhibit 1) are for a total of nine machines in each case.
The total cost of the ‘Matz’ machines under consideration is $332,000, whilst for the ‘Ebz’ machines the cost is $317,000. In addition to these machines, an expenditure of $108,000 and $133,000 respectively is required for auxiliary equipment.
Estimated cash-flows and other data
|Annual Sales Revenue||1,300,000||1,305,000|
|Annual Operating Costs||b||1,052,000||1,044,000|
|Every 5 years||d||60,000|
|Every 6 years||80,000|
|Required increase in working capital||20,000||30,000|
|Expected Useful Life||10 years||12 years|
a) An investment allowance of 10 per cent is claimable on these initial outlays for taxation purposes, for the year of the expenditure.(end of year)
b) Annual operating costs include all direct costs of manufacture, together with factory, selling and administrative expenses, but exclude taxation, depreciation and interest.
c) Depreciation for tax purposes is to be claimed at the rate of 20 percent per annum on a straight-line basis.
d) Costs of overhauls are to be capitalised for accounting purposes, and amortised over :
• five years if the ‘Ebz’ equipment is acquired, or
• five years if the ‘Matz’ equipment is acquired.
It is expected, however, that this cost will be claimable as a tax deduction in the year of the expenditure.
The management is also considering two types of machines to replace the existing equipment.
• The ‘EM’, which is a relatively small and inexpensive machine; and
• The ‘JB’, a larger and more durable machine with a higher capacity.
The expected cash flows and other information relating to one of the old machines and the two types of replacement machines under consideration are given in Exhibit 2.
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The existing equipment, which consists of four of the old type machine (an early model ‘JB’) originally cost $100,000 in total, six years ago, and has been fully depreciated for taxation purposes. Expected future sales volume is expected to absorb an overall production volume of 4,000 units per hour.
It is considered necessary to have only one type of machine in operation for three reasons:
1. Existing material handling and packaging equipment will be used to full advantage.
2. Inter-changeability of moulds and spare parts permits greater flexibility in production scheduling, and requires a smaller stock of spare parts.
3. Regular maintenance and periodic overhauls will be more economical.
The installation of the ‘EM’ machines would require considerable modification to existing ancillary equipment. The additional cost of these modifications is incorporated in the cash flows given in Exhibit 2.
1. Expenditure on repairs and maintenance is to be capitalised in accounting records and amortised five years respectively. It is expected, however, that these amounts will be deductible for tax purposes in the year the expenditures are made.
2. Depreciation for tax purposes is to be claimed at the rate of 20 per cent per annum on a straight-line basis.
3. An investment allowance of 10 per cent is claimable on these initial outlays for taxation purposes, for the year of the expenditure.
An advantage to be gained from the installation of the ‘EB’ equipment is that it would make production scheduling more flexible, and thus permit a reduction in inventories.
The company charges depreciation on a straight-line basis for financial reporting purposes. Management policy is to discount all new projects at a discount rate of 10%. The current rate of company tax is 40 cents in the dollar.
1. Evaluate the alternative capital investments. Justify your answers to the following questions with full explanations. You will need to calculate the net present value, internal rate of return and payback period for each alternative.
2. The old machines can either be replaced now or in four years’ time. Calculate the net present value foregone by keeping the old machines for another four years.
3. Which replacement equipment (EM or JB) alternative would you recommend, and for what reasons?
4. Which new machine (Matz or Ebz) alternative would you recommend, and for what reasons?
5. Which combination of Matz and Ebz and EM and JB would be recommended?
6. Although management expects that inflation will remain constant over the term they have requested a schedule showing the impact of inflation on the net present value of the proposals over the range one to ten per cent. Graph the results and briefly interpret the data and graph.
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