Reference no: EM132541165

Olourun Ltd is the major employer in the Front Hill area, where the firm is located. The company is considering the acquisition of a new production line. The equipment would cost $720 000 and installation cost would amount to $59 000. At the end of its 5-year life, it is expected to be disposed of at its salvage value of $70 000. The new equipment would allow the company to expand production significantly, which would require an increase in working capital of $90 000. If the purchase is made, the firm's maintenance costs would be reduced by $60 000 annually. However, at the end of the third year, a major overhaul would have to be undertaken at a cost of $80 000. Operating cash flows would be $220 000 in the first year; this would increase by 2% for of the following years.

The company's cost of capital is 14% and the relevant corporate tax rate is 25%

Question 1: Calculate the relevant after-tax net cash flows and after-tax profits over the life of the investment.

Question 2:  Compute the project's ARR

Question 3:  What is the payback period?

Question 4:  Using the NPV as the basis of your decision, advise Olourun as to whether the company should purchase the equipment.

Question 5:  Would you advise the company to base their decision on the payback method rather than the NPV as used above?

Question 6: Compute the IRR of the project

Question 7: The company is considering another investment would have an initial cost of $800 000 and an NPV of $65000. There is a situation of capital rationing, and you have suggested that the firm should

Question 8: Discuss THREE non-financial factors which the firm should consider when making this decision.

Question 9: Why is it important for the company to know its cost of capital when making investment decisions?