Expert Q&A; Done Question 11: Capital Budgrning senior management has Uggle Wugg

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Expert Q&A; Done Question 11: Capital Budgrning senior management has Uggle Wuggle Limited is a manufacturer of machine equipment prodact. The s of a new set of manufacturing plant that would aid in revolutionizing the machine company's products. The company has allocated a total proposed the purchase capital budget of $55,000,000 maximum A consultant has been engaged by the company, and has provided the following summary manufacturing process, and also the New oquipment if purchased will cost $42,500,000 immediately for a salvage value of $4 500,000 Old equipment currently planned to be sold for $1,300,000 in four years could be sold estimated that the purchase of the new equipment will resulet in an increase of sales of 12,650,500 per year . Iis i cs willal c prw oquipenent is parchased e Fixed costs will remain constant . If the new equipment is purchased, then this will increase the level of inventory immediately by The new equipment is estimated to have a useful life of four years and will depreciated to zeno . The cost of the report from the consultant was $1,500,000 2.880,000 whilst accounts receivable will decline by $4,200,300 and accounts payable by $2.650,000 during that span using straight-line depreciation. At the end of five years, it is estimated the salvage value on the new equipment will be $2,595,000 .If the new oquipment is purchased, it will result in an external rise in sales of a subsidiary to the value of $1,502,000 per year The weight average cost ofcapital ofthe company is estimated to be 8% * Ignore taxation Required: (1) Calculate the net prescnt value of proposed purchase of the new equipment (2) Basod on your calculation in Part (1), is the internal rate of return (IRR) of the project higher lower stify your answer. (3) One of the senior management is concermed that the consultant's calculation of the weightod- average cost of capital is too high and suggests applying a lower rate. If a lower rate is used, what will be the impact on the NPV you calculated in Part (1) (4) Another director has suggested the company should invest in another set of equipment that would be independent of the initial suggestion. The director has said the alternative equipment to be NUhased would yield an IRR of145% Based on the weighted-average cost of capital calculated by the consultant, would you accept or reject the alternative proposition from the director? Jastify your anwwer (5) A junior executive has also soggested it would be more optional for the company to invest in a revolutionary piece of machinery that would yield a significantly higher positive NPV than any of the other seggested projects. The initial outlay for this revolutionary equipment s Assuming the (I )i, would ntial suggested purchase yicelded a positive NPV (ignore your computation in Part ou sopport the parchase recommended by the junioe IT exocutive? Jlustify your answer. d Solution Pat () Year Year 1 Year 2 Year 3 Year 4 sitial Punchase 342.500 00 Working Capial Cane $1.329 500 00

Explanation / Answer

Year 0 Year 1 Year 2 Year 3 Year 4 a) Initial purchase -42500000 b)Salvage value of old equipment 4500000 c)Working capital changes -1329500 d)Sales increase 12650500 12650500 12650500 12650500 e)Variable costs -5114600 -5114600 -5114600 -5114600 f)Working capital recovery 1329500 g)Salvage value of new equipment 2595000 h)Opportunity salvage cost-Old equipment -1300000 i)Cashflow (a+b+c+d+e+f+g) -39329500 7535900 7535900 7535900 10160400 j) Discount rate @8% (From present value table) 1 0.926 0.857 0.794 0.715 k) Present value (i*j) -39329500 6978243 6458266 5983505 7264686 NPV Sum total of K -12644800 Explanation Initial purchase-Purchase cost of new equipment (Outflow) Salvage value of old equipment-Sale value of old equipment if sold immediately (Inflow) Working capital changes If new equipment is purchased, Increase in inventory 2880000 Outflow Decline in accounts receivable 4200500 Inflow Decline in accounts payable 2650000 Outflow 1329500 Outflow Sales increase-Increase in sales due to purchase of new equipment Variable cost-Increase in variable cost due to purchase of new equipment Working capital recovery-Working capital recovery will happen at the end of year as a cash inflow. Salvage value of new equipment-Sales value of new equipment Opportunity salvage cost-Salvage value of old equipment if sold at the end of 4 years

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