Reference no: EM132615335
Duo Co needs to increase production capacity to meet increasing demand for an existingproduct, 'Quago', which is used in food processing. A new machine, with a useful life of fouryears and a maximum output of 600,000 kg of Quago per year, could be bought for $800,000,payable immediately. The scrap value of the machine after four years would be $30,000.
Forecast demand and production of Quago over the next four years is as follows:
Year 1 2 3 4
Demand (units) 1.4 million 1.5 million 1.6 million 1.7 million respectively
Existing production capacity for Quago is limited to one million kilograms per year and thenew machine would only be used for demand additional to this.The current selling price of Quago is $8.00 per kilogram and the variable cost of materials is$5.00 per kilogram. Other variable costs of production are $1.90 per kilogram. Fixed costs ofproduction associated with the new machine would be $240,000 in the first year ofproduction, increasing by $20,000 per year in each subsequent year of operation.Duo Co pays tax one year in arrears at an annual rate of 30% and can claim capital allowances(tax-allowable depreciation) on a 25% reducing balance basis. A balancing allowance isclaimed in the final year of operation.Duo Co uses its after-tax weighted average cost of capital when appraising investmentprojects. It has a cost of equity of 11% and a before-tax cost of debt of 8·6%. The long-termfinance of the company, on a market-value basis, consists of 80% equity and 20% debt.
Required:
Problem (a) Calculate the net present value of buying the new machine and advise on theacceptability of the proposed purchase (work to the nearest $1,000).
Problem (b) Calculate the internal rate of return of buying the new machine and advise on theacceptability of the proposed purchase (work to the nearest $1,000).
Problem (c) Explain the difference between risk and uncertainty in the context of investment
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