Hanna manufactures components for the farming industry and is considering replacing its existing equipment with new and more high technology machinery, despite the fact that its existing equipment is only a few years old and still working well.
The existing machinery will be fully depreciated in 5 years time but will have sufficient machine hours left to remain functioning for another 15 years. If Hanna purchases new equipment, the old machinery could be disposed of for $2,500,000.
The new equipment would cost $65,000,000 and for tax purposes it would fall into a declining balance CCA class. To stimulate the economy, the recent budget stipulates that for year 1 the CCA rate would be 45%, reducing to 40% in year 2, and then returning to 30% thereafter. This equipment would have a useful life of 10 years, after which it is expected to be disposed of for proceeds of $3,000,000
To make this new machinery operate, customized software totaling $10,000,000 would be purchased. Unlike the machinery, for tax purposes this equipment would fall into a straight line CCA class over a 5 year period.
The new equipment will enable Hanna to immediately reduce its Work In Process on the factory floor by $1,500,000. However to support sales, it is expected that receivable will need to increase by $6,000,000 at he start of the first year and by another $2,000,000 at the end of year 6
The Annual fixed costs for the new system will be $7,500,000
Hanna Management believe that they have little choice but to move forward with the new equipment as they are convinced their competitors will bring out a product that will reduce their current annual volume from 200,000 units to 175,000 if they do not follow suit with a similar high quality product that can only be made with the new equipment.
The current product sells for $500 per unit and given the expected competitive response, it is expected the price will not be able to be increased for the new higher quality product manufactured with the new machinery.
Selected data for the existing product include: $ per #
Selling price per unit 500
Direct material cost per unit 130
Direct labour cost per unit 150
Variable overhead cost per unit 50
Fixed overhead per unit 16
Total Cost 346
Gross margin per unit 154
It is expected that once the new machinery is installed, savings will occur with a reduction in the cost of direct materials by $15 per unit. In addition, direct labour will be reduced by 20% and variable overhead by 10%. The existing fixed costs include $4 per unit of depreciation.
Hanna Manufacturing has a 40% income tax rate and its weighted average cost of capital is 12%. Calculate the net present value of this project, and recommend to management if the project should be accepted.
HINT - be sure to consider the change in incremental cash fixed costs.
AFTER PAYMENT ENTER PASSWORD : "shiv" TO UNLOCK THE SOLUTION
The existing machinery will be fully depreciated in 5 years time but will have sufficient machine hours left to remain functioning for another 15 years. If Hanna purchases new equipment, the old machinery could be disposed of for $2,500,000.
The new equipment would cost $65,000,000 and for tax purposes it would fall into a declining balance CCA class. To stimulate the economy, the recent budget stipulates that for year 1 the CCA rate would be 45%, reducing to 40% in year 2, and then returning to 30% thereafter. This equipment would have a useful life of 10 years, after which it is expected to be disposed of for proceeds of $3,000,000
To make this new machinery operate, customized software totaling $10,000,000 would be purchased. Unlike the machinery, for tax purposes this equipment would fall into a straight line CCA class over a 5 year period.
The new equipment will enable Hanna to immediately reduce its Work In Process on the factory floor by $1,500,000. However to support sales, it is expected that receivable will need to increase by $6,000,000 at he start of the first year and by another $2,000,000 at the end of year 6
The Annual fixed costs for the new system will be $7,500,000
Hanna Management believe that they have little choice but to move forward with the new equipment as they are convinced their competitors will bring out a product that will reduce their current annual volume from 200,000 units to 175,000 if they do not follow suit with a similar high quality product that can only be made with the new equipment.
The current product sells for $500 per unit and given the expected competitive response, it is expected the price will not be able to be increased for the new higher quality product manufactured with the new machinery.
Selected data for the existing product include: $ per #
Selling price per unit 500
Direct material cost per unit 130
Direct labour cost per unit 150
Variable overhead cost per unit 50
Fixed overhead per unit 16
Total Cost 346
Gross margin per unit 154
It is expected that once the new machinery is installed, savings will occur with a reduction in the cost of direct materials by $15 per unit. In addition, direct labour will be reduced by 20% and variable overhead by 10%. The existing fixed costs include $4 per unit of depreciation.
Hanna Manufacturing has a 40% income tax rate and its weighted average cost of capital is 12%. Calculate the net present value of this project, and recommend to management if the project should be accepted.
HINT - be sure to consider the change in incremental cash fixed costs.
AFTER PAYMENT ENTER PASSWORD : "shiv" TO UNLOCK THE SOLUTION
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