Reference no: EM132795451

Your new assistant has brought you the following analysis of an investment you are considering. The investment relates to a new manufacturing process for making one of the company's major products.

Required Investment

New machinery (10-year life, no salvage value) P1,750,000
Research and development 300,000
Administrative time 50,000
Annual cash flows (10 years)

Savings in cost over old process:

Labor P375,000
Materials 400,000
Variable overhead 200,000
Depreciation (175,000)
Total operating savings P800,000
Less: Interest on debt to finance investment 175,000
Net savings before taxes P625,000
Less: Income taxes 30% 187,500
Net cash flow after taxes P437,500

• Your assistant tells you that the new machinery would replace old machinery that has a 10-year remaining useful life with no salvage value. The old machinery will be scrapped if the new machinery is bought, and the salvage value equals the cost of having it removed. The old machinery has a book value of P550,000. The company uses a straight-line depreciation for all machinery.
• Your assistant also tells you that the listed costs for research and development and for administrative time relate solely to this project and contain no allocations. The costs have already been incurred, so their amounts are certain. The item in the analysis for interest on debt is for P1,750,000 at 10%, which will be borrowed if the new machinery is acquired.

Based on his analysis and the 16% cost of capital, he recommends that the project be rejected.

Required:

Problem 1: Determine whether you should make the investment. Show your computations.