Question: Capital Budgeting Task
You are helping NCC Technologies with its capital budgeting decisions. The company is a producer and wholesaler of electronic parts, has a 15% cost of capital and is subject to a 30% tax rate. There are two major proposals on which NCC Technologies would like your advice.
1. The device part project
NCC Technologies is considering whether it should expand into production of a part for a new generation of mobile devices. Trends suggest these devices and their parts will offer high growth in the early years of a 5-year life cycle.
The new plant and equipment needed to produce the part will cost $1,000,000, which the business will depreciate for tax purposes using a prime cost rate of 10% per annum. When the project is wound up at the end of five years, the general purpose equipment is expected to be sold for an estimated $400,000.
Sales in the first year are expected to be $3,000,000, increasing at a high rate of 15% in the second and third years and then falling by 20% per year for the last two years of the project as demand declines due to competing new technologies. Consultants called in previously by NCC Technologies, who were paid $50,000 in fees, estimated that variable costs for the project will be 50% of its revenues. Building rental, fixed salaries and other fixed costs directly related to the project are expected to be $1,400,000 in the first year and increase by 3% per year thereafter. The investment in net operating working capital related to the project is expected to be 15% of the following year's sales revenues. This investment will be recovered by the end of the project. It is also thought that the project will encourage additional after tax profits of $100,000 per year for NCC Technologies' existing part range.
2. The conveyer system
NCC Technologies needs to install a conveyer system as soon as possible because the existing system, which has no scrap value, is beyond repair. Three different systems are being considered. The first, System A, is the same type of system as the old one - just a newer model. It will last 10 years and cost $35,000 to purchase and install. The second, System B, will last 10 years and cost $50,000 to purchase and install. The third, System C, will last 20 years and cost $120,000 to purchase and install. None of the systems will have any expected salvage value but all will be replaced at the end of their lives.After examining all costs, the net cash outflows for each system are: $15,000 per year for System A; $11,000 per year for System B; and $1,500 per year for System C.
Requirements-
Provide NCC Technologies with a memo that provides your recommendations on the two proposals. Your memo should also include details of your analysis and briefly explain and justify your chosen methods and any assumptions made. Table format for presenting figures is preferable.