Question

FTG commissioned a study to look into the feasibility of changing the packaging of the fruit from cans to sealed bags. The Consultant charged $54,000 for the report.

The report concluded that the new packaging will increase sales and reduce some operating costs.

The new packaging machinery will cost $1,100,000. The new machine is expected to last 5 years. The Taxation Office advise the life of the machine, for tax purposes, is 4 years.

The old canning machinery was purchased 2 years ago for $800,000 and was being depreciated at $200,000 and will be for the next 2 years. The old machine could be sold today for $260,000. In 5 years it will be worth nothing.

Installing the new machine will require staff training (a tax deductible expense) of $35,000 before production can commence. Due to the lower cost of the bags Inventory required will be reduced by $80,000 for the life of the project.

The new sales of bagged fruit is expected to be $700,000 in Year 1 rising by 15% for 2 years then 0% for the rest of the life of the project. Variable Costs associated with the new packaged fruit are 50% of sales.

Canned fruit production will be discontinued. Sales of canned fruit were static at $450,000 with variable costs of $225,000 (50% of Sales).

The new equipment is very hi-tech. Maintenance costs are expected to be higher at $44,000 per year. Maintenance costs on the old machine were $30,000 per year.

The lighter packaging will reduce annual freight cost significantly from $250,000 to $100,000 per year.

Fixed costs are expected to remain at $320,000 per year.

At the end of the project the new machinery can be sold for $275,000.

Notes:

FTG will borrow the full Year 0 funds using a secured five-year interest-only loan at an interest rate of 10% per annum to finance the new equipment.

The company tax rate is 30%.

The required rate of return is 12.5%.

Requirement:

5. The NPV of the project （5Marks）

6. The IRR of the project（5Marks）

7. The PI of the project（5Marks）

Answer 1

		YEAR 0 FUND NEEDED
		NOTE:$54000 charged by consultant is a sunk cost and not relevant to this analysis
	A	Cost of new equipment	$1,100,000
	B	Current market Value of old equipment	$260,000
	C	Depreciation of old equipment in first two years	$400,000	2*200000
	D	Current book value of old equipment	$400,000	(800000-200000)
	E	Loss on sale of old equipment	$140,000	(400000-260000)
	F	Tax savings due to loss old equipment	$42,000	(3160*30%)
	G=A-B-F	Net Cost of New Equipment	$798,000
	H	After tax cost of staff trainning	$24,500	(35000*(1-0.3)
	I	Reduction of Inventory	$80,000
	J=G+H-I	NET FUND NEEDED IN Year0	$742,500
		Annual interest cost on borrowed fund	$74,250	(742500*10%)
			INCREMENTAL DEPRECIATION
			N	A	B=A*1100000	C	D=C*800000	E=B-D	F	G=E*F
			Year	Recovery Rate for new equipment	Depreciation on New Equipment	Recovery Rate for old equipment	Depreciation on old Equipment	Incremental Depreciation	Tax Rate	IncrementalTax shield benefit
			1	25.00%	$275,000	25.00%	$200,000	$75,000	30%	$22,500
			2	25.00%	$275,000	25.00%	$200,000	$75,000	30%	$22,500
			3	25.00%	$275,000	0.00%	$0	$275,000	30%	$82,500
			4	25.00%	$275,000	0.00%	$0	$275,000	30%	$82,500