Reference no: EM132707581

Question - Ferris Industries is planning to replace its old equipment.

The old equipment cost was $350 000 five years ago. The old equipment is fully depreciated.

If the new equipment is purchased, arrangements will be made to sell the old equipment. The old equipment is expected to be sold for only $20 000 on 1 January 2021.

The new equipment will be placed in service on 1 January 2021. The details regarding the proposal are as follows:

Expected acquisition cost $290 000

Expected installation $20 000

Expected investment allowance in year 1: 15%

Estimated useful life: 7 years

Expected salvage value which can be realised upon its disposal at the end of 7 years $30 000

Expected increase in sales due to the special production run of the new equipment Year 1 to year 7 4000 units each year

The selling price per unit expected to remain at $300

The variable cost per unit is expected to be $250

Expected increase in annual fixed costs due to the special production run of the new equipment is $62 000.

It is assumed that all cash flows occur at the end of each year.

The taxation depreciation on the equipment would be 25%per annum using the straight line method.

The company is subject to a 40% tax rate

The company uses a 12% after-tax discount rate.

Required -

1. Calculate the incremental profit (before tax) for each year due to the expected increase in sales.

2. Calculate the incremental after-tax cash flows for each year for Ferris Industries proposal to acquire the new equipment.

3. Should Ferris Industries invest in new equipment? Answer on basis of your calculations. Calculate and interpret the following for the proposed investment, the after tax

4. Calculate the net present value.

5. Calculate the internal rate of return (hint: use goal seek function in excel or trial and error method).

6. Calculate the payback periods.