Reference no: EM132555177

Point 1: Wotton Industries (WI) is considering whether to produce a new type of fence for cattle yards. The managers of WI believe that these fences will be suitable for cattle, camels, sheep and goats. Due to their streamlined appearance, they could also be used at race tracks and show grounds. However, producing the new fences will require new production machinery.

Point 2: Over the past six months, WI has spent $26,000 evaluating three options for producing the new fences, and has settled on a machine from Western Australia that costs $260,000. It is more ecient than their existing machines, and is expected to reduce raw material requirements. WI is considering a 5 year bank loan at an interest rate of 4.85% to finance the new machine purchase, with payments of $59,804.65 per year.

Point 3: One of the existing fence production machines will no longer be required if WI decides to purchase the new machine. Although the old machine has been fully depreciated for tax purposes, it can be sold for $15,000. The new machine can be depreciated straightline over 10 years for tax purposes. However, it will only last for 5 years, before requiring replacement.

Point 4: The existing machine is very compact and occupies a small part of WI's factory space. The company has been renting its spare factory space to a third party for $48,000 p.a. Due to the larger size of the new machine, WI will have to cancel that lease and take over the space. This will require a compensation payment of $22,000 to the tenant, which is an allowable tax-deduction when paid.

Point 5: The new machine will have an estimated salvage value of $47,000 at the end of its life in five years' time. It will also require specialist installation, which will be performed by an outside team for $32,000. This cost is tax-deductible.

Point 6: WI estimates that producing the new fences will increase its sales by $145,000 p.a. However, variable costs are likely to increase by $18,000 p.a. as well. The more ecient new machine will enable WI to reduce its holdings of raw materials by $16,000 p.a.

Point 7: The management deprecation policy at WI requires all assets to be depreciated over a five year period. The company's tax rate is 30%, and its required rate of return for new projects is 8% p.a.

Question (a) Calculate the cash flows at the beginning of the project.

Question (b) Calculate the recurring cash flows during the life of the project.

Question (c) Calculate the cash flows at the end of the project.

Question (d) Should WI invest in the new machine?