Reference no: EM132949910

The company Smart Inc. is a company that produces T-Shirts in Sudbury area. The results of the company, for the past couple of years, have been presented in the annual financial statement.

Sales (800000 units x 18$)                            14 400 000$

Variable Costs (800000 units x 10$)                  (8 000 000)

Fixed Cost                                                    (6 000 000)

Annual Profit (loss)                                            (400 000)

Experts suggest to the board of directors to replace the old equipment by new ones in order to improve the production and the profitability of the company. The price of the T-shirts will remain the same. However, the variable cost per unit will decrease by 10% while the fixed costs increase by 20%.

Considering the following information, the board of directors asks you to evaluate this project for the company.

• The new equipment would increase the level of production by 30%. The purchase (including the installation) of the new equipment requires an initial investment for an amount of 9 000 000$. The old equipment can be sold in the beginning of project on the market for 500 000$ (For simplification, consider this amount as an exchange value).
• The new equipment will be sold for 1 500 000$ in 10 years (end of project). The project also requires major renovations of the factory building for a total amount of 1 500 000$ (The amount of major renovations is depreciable with declining method under the tax law).
• The company also has to build a new building at the beginning of the project for an amount of 1 800 000$ which will be sold at the end of the project for 2 200 000$. This amount is depreciable with declining method.
• The project also requires an additional investment in new Computers and furniture for a total amount of 500 000$ in the beginning of project. Computers and furniture have no salvage value.
• At the present time, Smart Inc. is renting a warehouse for the annual rent of 100 000$ (paid at the end of year). If the company undertakes the new project, they will need to cancel the lease of the old warehouse and to rent a larger warehouse for the annual rent of 300 000$ (to be paid annually at the end of each year).
• The project also requires 5 new technicians today with annual salary of 80 000$ for each.
• Given the performance of new equipment, Smart Inc could lay off 40 employees whose annual salaries is 50 000$. The lay-offs will oblige the company to pay lay-off premiums for the total amount of 20 000$ to each employee today which is tax deductible. The corporate tax rate is at 40%. The new equipment and new heavy machinery are in the category with a depreciation of 20%, the major renovations are depreciated at 25%, the new building is depreciated at 10%, all items depreciations are calculated with decreasing (declining) method. The computers and furniture are depreciated by linear method at 10%. Investors require 12% return on this type of project.

Given this information, answer the following questions:

Problem 1: Calculate the maximum amount that the company can pay for the new equipment in order to keep the project profitable.