Question

930 The directors of Silberman Ltd are considering a proposal for a new machine that is estimated to cost £2,500,000. This would enable the company to manufacture a superior, additional new product, product Z. The accountant has prepared the following profit forecast on the assumption that the funds will be borrowed and the loan repaid at the end of the project: Profit forecast Year 1 Year 2 Year 3 Year 4 £000 £000 £000 £000 Sales 3.125 3.750 5,000 6.250 Less: Cost of sales 1,875 1,950 3,450 4,200 Other production expenses 550 575 700 940 Administration charge 750 820 1,050 Interest on loan 100 100 100 100 Profit/(loss) (150) 305 (180) (40) The figures in the profit forecast are based on the following: Cash received from sales and paid for costs will coincide with the financial year. The administration charge is an apportionment of central administration fixed overheads. It is assumed that the product has a four-year life. The machinery could be sold for £400,000 at the end of year 4. The other production expenses include the depreciation of the machine, using straight line depreciation. The following additional information not included in the profit forecast above is available: The production manager has said that if the new machine were installed there would be sufficient capacity to enable an existing machine to be sold immediately for approximately £350,000 and would create annual operating savings of £250,000. However, the accountant has told him that the existing machine currently stands in the books at £675,000 and the company could not afford to write off the asset against this year's profits. Initial market research for the new product has been performed by marketing consultants whose fee of £110,000 has just been received. The accountant has not included the following costs in the four-year profit calculation: The directors have spent a considerable amount of time on this project so far and they estimate the costs of their time equates to £50,000.

Answer 1

Question A&B Year o year 2 Sales Less:Cost of Sales Cash Inflow Salvage Year 1 3,125 (1,875) 1,250 3,750 (1,950) 1,800 Year 3 5,000 (3,450) 1,550 £'000 Year 4 6,250 (4,200) 2,050 400 (2,500) 350 Cash Outflow Sale of existing machine Annual Operating Saving Advertising and sales Promotion Maintenance Cost Replacement of Key Component (400) 250 (80) (25) 250 (80) (35) (65) 70 250 (60) (49) 250 (60) (69) (2,550) 145 141 121 (2,550) 1,870 2,571 1,395 0.909 1,268 0.826 Cash Flow Discount Factor @10% Present Value Net Present Value 1,691 0.751 1,270 0.683 1,545 1,756 (2,550) 3.290 It is advised to invest on project as NPV is positive Note: Sunk Cost are not relevant cash Flow-Initial Market research and Director time Administration charges which is apportioned and depreciation are not relevant cash flow Interest on loan is a provisional amount Loan based on assumption) Year 0 Sales Less:Cost of Sales Cash Inflow Salvage Year 1 3,125 (1,875) 1,250 year 2 3,750 (1,950) 1,800 Year 5.000 (3,450) 1,550 £'000 Year 4 6,250 (4,200) 2,050 400 (2,500) 350 Cash Outflow Sale of existing machine Annual Operating Saving Loss of Contribution-Product W Loss of Contribution-Product G Advertising and sales Promotion Maintenance cost Replacement of Key Component 250 (250) (180) (80) (25) 250 (200) (140) (80) (35) (65) (270) 250 (250) (96) (60) (49) 250 (176) (78) (60) (69) (400) (2,550) (285) (205) (133) Cash Flow Discount Factor @10% Present Value Net Present Value (2,550) 1 (2,550) 2,185 965 0.909 877 1,530 0.826 1,264 1,345 0.751 1,011 2,317 0.683 1,583 625 500 500 400 40% 50% 44% 40% 250 200 250 176 Product W Sales Contribution Ratio Contribution Product G Sales Contribution Ratio Contribution 600 500 400 300 30% 180 28% 140 24% 96 26% 78 D The book value refers to how much a given asset is worth on the company's accounting records (i.e., how much it's been depreciated). It is different from the salvage value, as it does not represent a cash inflow or outflow. It is only used to calculate any gains or losses from the sale of old assets. E Cash Flow Budget-The analysis of cash-flow budget which shows the flow of funds into and out of the company affect capital investment decision Fiscal Incentives-Tax Concesions Market Forecasts-Short and long run market forecast required or capital investment decision Competitors strategy:If competitors continue install more equipment and strategy and succeed in turning out better products, the existence of the company not following would be seriously threatened Management Outlook