Ask Question, Ask an Expert

+1-415-315-9853

info@mywordsolution.com

Ask Basic Finance Expert

problem

NEC is considering the investment in a new machine, with maximum output of 200,000 units per annum, in order to manufacture a new toy. Market research undertaken for the company indicated a link between selling price and demand, and the research agency involved has suggested two sales strategies that could be implemented, as follows:

    Strategy 1     Strategy 2

Selling price (in current price terms)     RM8.00 per unit    RM7.00 per unit
Sales volume in first year     100,000 units     110,000 units
Annual increase in sales volume after first year     5%     15%

The services of the market research agency have cost RM75,000 and this amount has yet to be paid.

NEC expects economies of scale to reduce the variable cost per unit as the level of production increases. When 100,000 units are produced in a year, the variable cost per unit is expected to be RM3.00 (in current price terms). For each additional 10,000 units produced in excess of 100,000 units, a reduction in average variable cost per unit of RM0.05 is expected to occur. The average variable cost per unit when production is between 110,000 units and 119,999 units, for ex, is expected to be RM2.95 (in current price terms); and the average variable cost per unit when production is between 120,000 units and 129,999 units is expected to be RM2.90 (in current price terms), and so on.

The new machine would cost RM1,500,000 and would not be expected to have any resale value at the end of its life. Capital allowances would be available on the investment on the following basis:

Initial allowance – 20%
Annual allowance – 14%

Although the machine may have a longer useful economic life, NEC uses a five-year planning period for all investment projects. The company pays tax at an annual rate of 25% and settles tax liabilities in the year in which they arise.

Operation of the new machine will cause fixed costs to increase by RM110,000 (in current price terms). Inflation is expected to increase these costs by 4% per year. Annual inflation on the selling price and unit variable costs is expected to be 3% per year. For profit reporting purposes NEC depreciates machinery on a straight-line basis over its planning period.

NEC applies three investment appraisal methods to new projects because it believes that a single investment appraisal method is unable to capture the true value of a proposed investment. The methods it uses are net present value, internal rate of return and return on capital employed (accounting rate of return). The company believes that net present value measures the potential increase in company value of an investment project: that a high internal rate of return offers a margin of safety for risky projects; and that a project’s before-tax return on capital employed should be greater than the company’s before tax return on capital employed, which is 20%. NEC does not use any explicit method of assessing project risk and has an average cost of capital of 10% in money (nominal) terms.

Required:

(a) Find out the sales strategy that maximizes the present value of total contribution. Ignore taxation in this part of the problem.

(b) find out the investment in the new machine using internal rate of return.

(c) find out the investment in the new machine using return on capital employed (accounting rate of return) based on average investment.

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M94210

Have any Question? 


Related Questions in Basic Finance

Consider the following listing for 10-year treasury note

Consider the following listing for 10-year Treasury note futures on the Chicago Board of Trade. One futures contract for Treasury notes = $100,000 face value of 10-year 6% notes. a. If on this day you bought two contract ...

The following appeared in an article in the wall street

The following appeared in an article in the Wall Street Journal: Credit Suisse Group equity-derivatives strategist Sveinn Palsson suggests a "strangle" in the company's options. The strategy involves selling a call and a ...

Connectix inc recently issued noncallable bonds that mature

Connectix Inc. recently issued noncallable bonds that mature in 10 years. They have a par value of $1,000 and an annual coupon of 7.5%. If the current market interest rate is 7.7%, at what price should the bonds sell?

For the situation described in problem 2 above we expect

For the situation described in problem 2 above we expect elastic interaction loss of 6% and embedment loss of 4%. Compute the revised maximum and minimum preloads ? Sketch the revised, preloaded joint diagram ? Compute t ...

What distinguishes an ordinary annuity from an annuity due

What distinguishes an ordinary annuity from an annuity due? What distinguishes an ordinary annuity from a deferred annuity? If a cash flow is the same amount each period, ad infinitum, how do we value the present value o ...

You have a 1100 balance on your 15 credit card you have

You have a $1,100 balance on your 15% credit card. You have lost your job and been unemployed for 6 months. You have been unable to make any payments on your balance. However, you received a tax refund and want to pay of ...

J smythe inc manufactures fine furniture the company is

J. Smythe, Inc., manufactures fine furniture. The company is deciding whether to introduce a new mahogany dining room table set. The set will sell for $6,800, including a set of eight chairs. The company feels that sales ...

1 what is behavioral research what are its fundamental

1. What is behavioral research? What are its fundamental goals and limitations? Why is learning about behavioral research important? 2. In what ways is behavioral research similar to and different from research in the na ...

1 may personal financial statements be prepared only for an

1. May personal financial statements be prepared only for an individual? Comment. 2. What is the basic personal financial statement? 3. Is a statement of changes in net worth required when presenting personal financial s ...

Explain the differences among the three means of

Explain the differences among the three means of terminating a futures contract: an offsetting trade, cash settlement, and delivery. How is a forward contract terminated? Explain the difference between hedge funds and fu ...

  • 4,153,160 Questions Asked
  • 13,132 Experts
  • 2,558,936 Questions Answered

Ask Experts for help!!

Looking for Assignment Help?

Start excelling in your Courses, Get help with Assignment

Write us your full requirement for evaluation and you will receive response within 20 minutes turnaround time.

Ask Now Help with Problems, Get a Best Answer

WalMart Identification of theory and critical discussion

Drawing on the prescribed text and/or relevant academic literature, produce a paper which discusses the nature of group

Section onea in an atwood machine suppose two objects of

SECTION ONE (a) In an Atwood Machine, suppose two objects of unequal mass are hung vertically over a frictionless

Part 1you work in hr for a company that operates a factory

Part 1: You work in HR for a company that operates a factory manufacturing fiberglass. There are several hundred empl

Details on advanced accounting paperthis paper is intended

DETAILS ON ADVANCED ACCOUNTING PAPER This paper is intended for students to apply the theoretical knowledge around ac

Create a provider database and related reports and queries

Create a provider database and related reports and queries to capture contact information for potential PC component pro