FIN3701 ASSIGNMENT 1 OF SEMESTER 1 2023 []
QUESTION 1
Merck Ltd is a manufacturer of high-quality plastic products made to demanding specifications, which makes replication of designs difficult. The company relies on marketing programmes to ensure that models are constantly changed, and that ...
Merck Ltd is a manufacturer of high-quality plastic products made to demanding
specifications, which makes replication of designs difficult. The company relies on
marketing programmes to ensure that models are constantly changed, and that demand
follows new designs. This allows the company to maintain margins in a highly competitive
environment.
Merck Ltd is considering the replacement of outdated equipment, which will allow the
firm to manufacture a new line of products. The cost of the new equipment is R8,5 million
and the company qualifies for a depreciation deduction of 40% of cost for the first year,
and 20% in each of the subsequent three years. The equipment is also expected to result
in the sales revenue of R5 950 000 and total operational cost of R2 480 000 per annum
before tax for another four years, when the life of this product line is expected to end. The
expected after-tax proceeds from the sale of the new equipment amounts to R1 512 000
in four years’ time.
The current tax value of the present equipment is R300 000 and its current market value is
R410 000. The equipment is expected to have a residual value of zero in four years’ time.
The investment in net working capital will amount to R475 000. The marginal tax rate is
28% and the firm has a cost of capital of 12%.
REQUIRED:
1.1 Calculate the net present value (NPV), internal rate of return (IRR) and payback period
(Pb) for the replacement. (18 marks)
1.1 State based on the NPV, IRR and Pb whether the company should replace the
equipment.
NB: The maximum acceptable payback period for Merck Ltd is 1.5 years. (2 marks)
1
, REQUIRED:
1.1 Calculate the net present value (NPV), internal rate of return (IRR) and payback period
(Pb) for the replacement. (18 marks)
QUESTION 1.1
Net present value, internal rate of return and payback period calculations.
Proceeds from the sale of current equipment
Capital gains: (SP – BV) R410 000 – R300 000 = R110 000
Capital gains tax (Gains x Tax) R110 000 x 0.28 = R30 800
Proceeds from sales: (Proceeds – Tax) = R410 000 – R30 800 = R379 200
Initial investment
Cost of new machine (R8 500 000)
Proceed from the old machine *R 379 200
(R8 120 800)
Change in NWC (R 475 000)
(R8 595 800)
2
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