Reference no: EM133179859

Question - After-tax cash flows; investment in advanced technologies: manufacturer Sophia Milan, the production manager of Italiano Footwear, is concerned about the company's ability to maintain its competitive position in the footwear market in Australia. There has been a recent surge of imported shoes priced well below Italiano's full product cost. One of Italiano's major competitors, Sparks Shoes, has responded to this recent flood of cheap imports by introducing computer-integrated manufacturing (CIM). Milan has determined that it would cost Italiano $120 million to purchase the relevant CIM equipment, which would have an expected life of 10 years and an estimated salvage value of $10 million at the end of that time. Assume that both the accounting and taxation depreciation use the straight-line method. However, the accounting depreciation is based on the depreciable amount, not the cost.

Once the equipment is commissioned the following annual benefits and costs will occur:

Fewer faulty products and less reworking, annual savings of $28 million.

Lower rental payments due to reduced space required for warehousing, annual savings of $8 million.

Increased revenue from improved quality resulting in higher price for shoes, annual revenue of $16 million.

Cost of maintaining the CIM equipment, $16 million per year.

Other financial impacts will include:

Reduced working capital associated with lower inventory and accounts receivable, $8 million. (Assume that these costs are incurred at the same time as the CIM investment is made.)

One-off costs of implementing CIM, associated with staff development and production losses during the implementation phase, $80 million. (Assume that these costs are incurred at the same time as the CIM investment is made and assume that they are capitalised with the initial purchase costs of $120 million.) These costs are included in the cost base for accounting and taxation purposes.

Required -

1. Use Excel to make the schedule of Italiano Footwear's after-tax cash flows that will result from the proposed CIM investment.

2. Calculate the net present value of the CIM proposal. Should Italiano go ahead with this proposal, given its current investment criteria? Explain why

3. Calculate the payback period (after-tax) for the CIM proposal.

4. Discuss the potential difficulties of Italiano Footwear using discounted cash flow analysis to make a decision about high-tech manufacturing equipment.