Question

In: Accounting

Singapore Clouds Ltd.’s (Microphone manufacturing and selling company), CFO, Mr. Michael has been asked by CEO,...

Singapore Clouds Ltd.’s (Microphone manufacturing and selling company), CFO, Mr. Michael has been asked by CEO, Mr. Ken, to assist with an investment appraisal.  They have recently completed a three-year feasibility study on whether, or not, to expand their market offerings and offer specially designed high-quality microphone for customers and invest in capital infrastructure for the production line.  The market research indicates no other competitors have ever sold this specially designed product before. It might open a completely new market for Clouds Ltd. In addition, it was revealed that this specially designed high-quality microphone could be sold via (e-trade) on-line trading system.

Clouds Ltd. is considering a proposal to acquire new machineries (which has an expected useful life of 6 years). If the company decides to purchase the new machineries, it will receive $ 74,000 for the existing machines in year 1. The existing machineries had been fully depreciated and the net book value of the assets is zero. The new equipment will be placed in service on 1 January 2021. The details regarding the proposal are as follows:

  • Expected cost of the new machineries: $ 2,965,000.
  • Expected installation costs of the new equipment: $ 35,000.
  • Expected increase in working capital at the beginning of operations $ 72,000 and expected working capital at the end of the project $ 58,000.
  • Expected investment allowance (tax free due to Covid-19 crisis) received from the government to support manufactures (at the end of year 1) is 10% of the total amount of capital invested (excluding working capital investment).
  • Expected salvage value at the end of year 6 is nil.
  • Expected repairs to maintain production efficiency (end of year 3): $ 127,000.
  • Working capital will be released at the end of year 6.
  • Expected increase in annual cash revenue: $760,000.
  • Expected increase in annual cash operating expenses: $ 74,000.
  • It is assumed that all cash flows occur at the end of each year.
  • The taxation depreciation on the equipment would be 20% straight line.
  • The company is subject to a 30% tax rate and has an after-tax required rate of return of 12%.

Required:

  1. What type of investment is Clouds Ltd making?  Provide details as to why you came to this conclusion and other considerations in making the investment decision.
  2. Calculate the Net Present Value (NPV) of the proposed investment after tax.
  3. Advise Clouds Ltd management whether they should proceed with the project.

Solutions

Expert Solution

a. The Company C is interested in long-term financing or long-term project. Investment decision related to ling-term projects is based on the Net Present Value (NPV). In case of positive NPV project is selected and in case of negative NPV, project is rejected.

b. The NPV of the project is calculated as follows:

Working Note:

c. The NPV of the project is negative. Hence management cannot accept the project.


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